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If the fed stays behind the curve on rate hikes already priced in, would that bring the short end yield down and long end up pricing in more inflation? If so could that scenario encourage more carry trade with wider spreads? Or do I have it wrong? The path of least resistance for the fed seems to be lower rates, higher inflation and probably better gold and silver prices.
Minyan Edward Nasser,
This concerns whether or not the Fed actually controls interest rates. They do control the Fed Funds rate and the supply of money, but they do not control market interest rates.
The Fed funds rate is only accessible to money center banks and broker dealers, the most levered of all market participants. So if the Fed stubbornly insists on keeping the Fed funds rate low while market rates are going up these participants can continue to build carry type trades. It is no coincidence that these are the riskiest situations.
Other than that, most market participants must borrow at "market" rates; the Fed does not have direct control over these. So as long rates rise, the short end of market rates gets pulled up and the carry trade goes away as the yield curve "flattens".
If you include Fed funds in the yield curve it begins to look like an upside down check mark: most of it flat with Fed funds much lower.
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