Forward Guidance
July 31, 2025

The Fed Is Ignoring The Most Important Signal

The Federal Reserve is laser-focused on traditional metrics, but it might be missing the forest for the trees. This analysis argues the Fed is ignoring potent inflationary signals from the equity market and, most critically, the US dollar, creating the risk of a policy error that could let inflation run wild.

The Equity Market Blind Spot

  • "When they say we don't look at the equity market, they might be making a mistake... it can be proven that it has a positive impulse on inflation."
  • The Fed’s dismissal of the equity market is a potential policy error. Soaring risk assets and rising speculation, reminiscent of the 1999-2000 bubble, directly contribute to inflationary pressures.
  • The wealth effect from a booming stock market stimulates demand, counteracting the Fed’s efforts to cool the economy.

The Dollar is the Real Story

  • "The dollar... is having this huge, huge, huge impulse on not just growth, but inflation... They haven't talked about the dollar at all. And I think they need to be talking about the dollar.”
  • Despite higher inflation expectations, markets have priced in 75 more basis points of Fed cuts by 2026 than they did in February. This has pushed the dollar down, creating a powerful inflationary impulse that spiked in Q1.
  • As an import-driven economy, a weaker dollar makes foreign goods more expensive, directly fueling inflation. It also improves liquidity and boosts earnings for US companies, as 30% of their revenues come from abroad.

Deconstructing the 10-Year Yield

  • "The 10-year was actually the most complicated... It was 10-year up, that's a tightening. Turns out it's not that simple."
  • A rising 10-year yield is not a simple tightening signal. Its economic impact depends entirely on what’s driving it higher.
  • A rise driven by strong growth expectations is not a tightening force. A rise from inflation expectations is stagflationary (bad for growth, bad for inflation). A rise from a higher term premium (risk) hurts both growth and inflation.
  • Currently, the 10-year's impact is neutral, as rising inflation expectations and a higher term premium are offsetting each other. It is not providing the economic brake many assume.

Key Takeaways:

  • The Fed's framework is overlooking the two most powerful forces at play: a hot equity market and a weakening dollar. This creates a dangerous feedback loop where an ill-timed rate cut could trigger a currency cascade, causing inflation to spiral out of control.
  • The Dollar is the Key Inflationary Signal. The Fed's silence on the weakening dollar is a major policy risk. A weaker dollar is the single biggest contributor to the current unacknowledged inflationary impulse.
  • Rising Yields Aren't Always Tightening. The impact of a higher 10-year yield is nuanced and currently neutral. The economy is not getting the braking effect from the bond market that policymakers might expect.
  • Beware the "Doom Loop". A premature Fed rate cut into a strong economy could trigger a sharp dollar sell-off, leading to an aggressive and uncontrollable spike in inflation.

Watch the detailed discussion here: Link

This episode reveals the critical market signals the Federal Reserve is ignoring—specifically, how a booming equity market and a weakening dollar are creating a powerful, under-the-radar inflationary impulse.

Why the Fed Can't Ignore a Booming Stock Market

  • The speaker’s analysis suggests that when speculative activity in markets is high, it should be seen as a leading indicator of inflationary pressure.
  • Speaker's Perspective: The speaker firmly believes this connection is not just theoretical. They state, "it can actually be proven that it has a positive impulse on inflation."

The Dollar's Decline: A Hidden Inflation Driver

  • Technical Context: This divergence is visible in OIS rates (Overnight Index Swap rates), which are market-based proxies for the future Fed funds rate. While OIS rates signal aggressive cuts, inflation swaps (derivatives used to hedge against inflation) show inflation remaining elevated.
  • Key Statistic: The market has priced in 75 basis points more in rate cuts by the end of 2026 than it had in February.
  • Strategic Implication: This dynamic creates negative real interest rates, a classic bearish signal for the dollar. For investors, this divergence is a critical indicator that the market is anticipating a policy environment that will fuel, not fight, inflation.

The Triple Impact of a Weaker Dollar

  • Corporate Earnings: With approximately 30% of S&P 500 revenues coming from abroad, a weaker dollar directly translates to higher reported earnings.
  • Systemic Liquidity: A falling dollar increases the supply of dollars globally, improving liquidity for both domestic and international markets.
  • Import Prices: As a major importer, a weaker dollar makes foreign goods more expensive for the U.S., directly raising import prices and contributing to headline inflation. The speaker notes, "the impulse from the dollar to inflation just spiked in Q1."

The 10-Year Treasury: Not a Simple Tightening Signal

  • Rising for Growth: If the 10-year yield rises because of stronger economic growth expectations, it is not a tightening force.
  • Rising for Inflation: If it rises due to higher inflation expectations, the impact is mixed—negative for growth but positive for inflation.
  • Rising for Risk: If it rises because of a higher term premium (the extra compensation investors demand for holding long-term debt due to risks like high deficits), it acts as a clear tightening force, putting downward pressure on both growth and inflation.
  • Current State: The speaker concludes that the 10-year's current impact is largely neutral, as the effects of higher inflation expectations and a rising term premium are offsetting each other.

The Fed's Dollar Blind Spot and the "Doom Loop" Risk

  • This silence is dangerous. The speaker revisits their "doom loop" thesis, warning that an inappropriate or premature rate cut could trigger a cascade in the dollar's value.
  • Strategic Warning: A collapsing dollar would aggressively fuel inflation, potentially forcing the Fed into a reactive, even more hawkish stance down the line.
  • Speaker's Critique: The speaker's tone is one of clear concern, emphasizing the Fed's lack of commentary on this critical variable. "They haven't talked about the dollar at all. And I think they need to be talking about the dollar."

Conclusion

The Fed is overlooking powerful inflationary signals from the equity market and the U.S. dollar. For investors and researchers, monitoring the dollar's trajectory and risk asset speculation is no longer optional—it is a critical tool for anticipating policy errors and identifying strategic opportunities ahead of the mainstream consensus.

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