Nordea strategists Ole Håkon Eek-Nielsen and Jan von Gerich argue the Federal Reserve is unlikely to cut rates and could even face pressure to hike as a potential energy shock lifts inflation risks. They compare current conditions with the 1970s, highlight stagflation dangers, and see investors demanding higher yields, especially at the long end of the US bond curve.

Energy shock complicates Fed policy outlook

"We have for quite a while been arguing for no more cuts from the Fed. Seems like we could be right for the wrong reasons. Even if we still struggle to see much weakness in the US labour market, it is the potential energy crisis that is the most important driver right now."

"This situation could be challenging for today’s version of Fed; balancing higher unemployment with higher inflation is never easy. The cuts that Warsh has promised to deliver will probably be even harder. The lessons learned in the seventies will probably make quite a few FOMC-members argue for hikes, but given the potential for higher unemployment some might also draw the same conclusion as many did back then and try to induce as little pain as possible."

"In the seventies core inflation topped out above 13% and interest rates peaked at 17%. Neither we nor the market is implying such an outcome, but the risk of such an extreme is now higher than before and perhaps the probability should be seen as higher than what the market is pricing in."

"The stagflationary impulse this potentially is could also be met by stimulus from the government to ease the pain inflicted on consumers. The downturn it produces is likely to increase the, already too high, budget deficits in the US. It seems likely that bond investors will demand higher interest rates to meet record high supply and increasing inflation."

"We already see quite some pressure from the supply side in the bond markets and have for quite a while been arguing for the upside in long end bond yields."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)