When you think about the likely evolution of Fed policy for the remainder of 2024, you pretty much have to toss out the distinct possibility that high rates are actually working at cross purposes with the inflation fight.

Despite copious evidence to suggest the Fed’s demand problem (i.e., there’s too much of it) is at least in part a function of the billions in interest income minted monthly by money market funds, and despite the flagrantly obvious role high mortgage rates continue to play in propping up home prices (i.e., by keeping resale supply off the market), there’s no chance the FOMC will cut rates in the name of fighting inflation.

In order words: There’s no chance the Fed will take the “radical” notion that high rates are facilitating (rather than hindering) US economic activity and contributing to sticky inflation into account when setting policy. Jerome Powell’s been accused of enough over two fraught terms as Fed Chair without being castigated as an Erdoganomics convert.

Instead, the Fed will cling to terminal for longer than they’d otherwise prefer assuming the US economy continues to outperform and core inflation refuses to surrender. Official after official went on record in recent days to emphasize that the rate cuts “planned” for this year are now a second-half story, assuming they’re a 2024 story at all.

On Thursday, during remarks in Washington, John Williams (not exactly a noted hawk) accidentally became the first top official to introduce two-way rate risk when he stumbled into an admission that additional hikes are at least not impossible.

The familiar figure above, updated to show this week’s equity selloff, suggests stocks may be embarking on a “catch down” process which, to let bears tell it, has a long way to go.

The straightforward interpretation is that high (or higher) for longer rates will force an unwind of the valuation expansion behind what counted as one the most spectacular five-month equity rallies in recent memory. But there’s a second-order concern too: The Fed has raised the risk of a “hard landing” later by encouraging (or at least countenancing) a “no landing” now.

“The Fed secured an ‘own-goal’ via [a] self-induced, premature easing in financial conditions through [their] embrace of the ‘insurance cuts’ path before inflation was fully put away which, in conjunction with persistent fiscal largesse from the government, has seen the market-implied probabilities of a phase-shift into an economically unstable ‘no landing’ scenario pick up delta in recent weeks,” Nomura’s Charlie McElligott said.

Recall that the April vintage of BofA’s Global Fund Manager Survey suggested “no landing” odds have risen sixfold since December. By contrast, almost no one sees a hard landing.

That may represent a failure of foresight on the part of survey panelists. As McElligott put it, “‘no landings’ end in ‘hard landings.'”

Equities — being an “efficient” discounting mechanism and all — have apparently made the connection, though. Or are at least beginning to recognize the tail risk.

Speaking of tail risks, inflation and geopolitics topped the list this month in BofA’s poll.

Again, it appears at least some fund managers are derelict in the second-order thinking department. The figure above shows the perceived odds of rekindled inflation rose sharply in recent weeks. If you think inflation’s suddenly a big(ger) tail risk, and you suspect that tail might’ve fattened, then you should immediately ask what it would mean if that tail risk’s realized.

So, what would it mean? In this context, it might mean today’s policy mistake (a premature pivot and the deliberate underestimation of neutral) is setting the stage for tomorrow’s (a grudging about-face that finds the Fed pivoting back to rate hikes on the way to crashing the proverbial plane).

Based on renewed demand for hedges, at least some market participants do get it. “The threat of this ‘no landing’ backdrop, and the growing perception of a Fed policy error by loss of inflation-fighting credibility — especially with nothing but ‘fiscal dominance’ ahead in the US regardless of who wins the election — has recently helped to ‘bid-up’ demand for downside as ‘tails have gotten fatter,'” Charlie went on.

Commenting in this week’s “Flow Show,” BofA’s Michael Hartnett suggested Q1’s “good news is good news” regime has morphed into a “good news is bad news” dynamic vis-à-vis macro overshoots and the read-through for the Fed trajectory. It’s possible, he said, that a “bad news is bad news” regime isn’t too far off, in which case the trade would be long bonds and short stocks.

All of this needs to be considered with geopolitical shocks, which can be bond bullish on some days (e.g., through the flight-to-safety trade) and bond bearish on others (e.g., via the inflationary read-through of supply shocks and a world at war). And then there’s the policy nexus: Rearmament’s expensive, which points to more borrowing and higher yields, particularly given the shifting buyer base for G-7 bonds. Ultimately, central banks could be called upon to underwrite that debt, lest the funding for national security (and, more aptly, international security) should become unduly expensive.

“The threshold for investors to seriously revisit the prevailing bearishness [in rates and bonds] is apparently higher than we might have otherwise assumed,” BMO’s Ian Lyngen and Vail Hartman said Friday, before quickly adding that in the context of Treasurys, “there is nonetheless a point at which geopolitics shifts from being traded as an inflation story in favor of a broader risk-off impulse,” at least in the near-term.

To let Hartnett tell it, the longer-term story’s the same. The end game, as it were, remains clear. “Western governments have promises to keep [and] wars to fund, [which] means higher inflation, higher yields and higher taxation until the likely central bank bailout of public sector,” he wrote.