What a difference a few days makes.

Late last week, overzealous markets were so convinced of their own rate-cut narrative that traders summarily dismissed an upside surprise on headline US inflation to focus instead on the next day’s producer price report  — on the way to pressing dovish Fed bets.

To be sure, it wasn’t completely irrational. Core US inflation (i.e., what counts for the Fed, if not for Main Street, where the price of things like food and gas actually matters) matched expectations and the PPI release was good news. Whether it was good enough to justify a ~25bps rally at the front end (and a concurrent escalation in rate-cut wagers) was debatable. And still is.

The figure above, which I used in the latest Weekly, suggests the dovish price action overshot. Given that, the setup for Chris Waller’s Tuesday remarks (and Wednesday’s US retail sales update) was asymmetric. Rates were arguably due for a hawkish correction.

Sure enough, Waller’s reluctance to bless the beast he created, alongside a very robust read on nominal spending, conspired to drive a sharp front-end selloff. The surprise uptick in UK inflation played a role too. In fact, it was the impetus on Wednesday ahead of the US retail sales print.

The figure below gives you some context for how things developed since Waller tipped the Fed’s dovish pivot (and inclination to cut rates multiple times in 2024) during remarks on November 28.

The curve bear flattened sharply in the US on Wednesday. The odds of a March cut, which hit ~80% just days ago, were trimmed to around 50%.

“Characterizing the flattening as ‘overdue’… speaks to the disconnect between the price action and the recent Fed rhetoric,” BMO’s Ian Lyngen and Ben Jeffery said. “As Waller’s comments that he sees ‘no reason to move as quickly or cut as rapidly as in the past’ continue to reverberate across financial markets, the stronger-than-expected UK CPI print left the market less convinced that a March Fed cut is a foregone conclusion.”

The retail sales release in the US only reinforced the point. “The jobs market is tight, inflation is above target, consumer spending is holding up and recent Fed commentary suggests they are in no hurry to loosen policy,” ING’s James Knightley wrote. He expects the first cut in Q2.

With all the evidence (i.e., the data and the Fed rhetoric) seemingly lining up against a March move, why does the market still put any stock (figuratively or literally) into an imminent rate cut? Well, probably because investors are tempted to believe past is precedent.

“Historically, the Fed tends to cut rates roughly six to nine months after the last rate hike,” SocGen’s Subadra Rajappa said. “Since the last rate hike was in July, the March timeframe seems appropriate for a policy pivot.” (Her base case isn’t for a March cut.)

Lyngen and Jeffery captured it well. “The missing ingredient hadn’t been the economic data nor a hawkish spin by policymakers, instead it was the unwillingness of investors to embrace the extra meeting (or two) at terminal versus applying the historical norms,” they said.