Monetary Policy

This week’s US Bond Strategy Special Report takes a look at the two most provocative papers presented at last month’s Jackson Hole conference.

While it is not yet time to bet against risk assets, we push back on the increasingly popular ideas that the wealthiest households and/or AI-related capex can keep the expansion going despite the wobbling labor market.

The Fed is mispriced for the rest of 2025. We explain why the dollar is poised to rebound and the trades to position for it. 

Median Fed unemployment rate projections are overly optimistic. The Fed will end up cutting more in 2026 than it currently anticipates.

The European Central Bank has achieved a soft landing. Inflation is back to target, with well-anchored inflation expectations. The unemployment rate is historically low, and real economic growth is stable, albeit weak. Given that little to no additional easing will come from the ECB, investors should underweight government bonds relative to equities.

In Section II, Chester reviews the outlook for stablecoins, cryptocurrencies, and central bank digital currencies.

In Section I, Doug notes that a negative stance toward stocks will require a meaningful and imminent deterioration in the US macro data given the ongoing impact of AI optimism on the global equity market. In Section II, Chester reviews the outlook for stablecoins, cryptocurrencies, and central bank digital currencies.

In a widely anticipated move, the RBA resumed cutting rates. However, with housing, consumption, and PMIs improving, we see little scope for the RBA to ease beyond market expectations.

The BoE is easing, but risks falling behind. Labor and growth cracks are starting to emerge, and the Bank may soon be forced to move more decisively. This report outlines why gilts remain a buy and sterling’s path is diverging vs. USD and EUR.

Chart 1 Inflation And Bond Yields Are Headed Lower Inflation And Bond Yields Are Headed Lower Turkey’s financial policymakers have pursued a disciplined and restrictive policy mix so far, delivering high real interest rates and curbing fiscal expansion even as the economy slows. This commitment to inflation control has paved the way for a pronounced decline in price pressures, prompting BCA’s Emerging Markets Strategy team to upgrade Turkish domestic bonds to overweight in its EM domestic bond portfolio. Similarly, Moody’s has recently upgraded Turkey’s credit rating and outlook. The lagged effects of the restrictive stance are now increasingly evident: real bank lending rates hover near 30%, real domestic demand growth is decelerating, and fiscal expenditure increases are barely keeping pace with inflation. Collectively, these conditions point to further disinflation and declining bond yields in the coming quarters (Chart 1).From an FX strategy perspective, the Turkish lira (TRY) presents a less precarious profile than many fear and what the forward markets currently imply. Chart 2 Weak Domestic Growth Means Narrow CA Deficit Weak Domestic Growth Means Narrow CA Deficit First, the current account deficit has narrowed considerably in recent years. As tight policy weighs on domestic demand, it will further curb goods imports and keep the current account deficit in check (Chart 2). This improvement should offset much of the expected export contraction due to slowing demand from the European manufacturing sector, reducing pressures on the lira from external balances. Second, the combination of receding inflation and very high nominal yields creates a compelling environment to attract sizable foreign portfolio flows into local currency debt. With foreign ownership of Turkish domestic government bonds currently low by historical standards, there’s significant room for new inflows (Chart 3). As such, the TRY depreciation over the next year will likely fall well short of the 26% pace currently implied by forward markets vis-à-vis the USD. Historically, periods of falling inflation have coincided with slower lira depreciation (Chart 4). A weaker trade-weighted US dollar could reinforce this trend, further curbing pressure on the currency. In this context, short-end local currency bonds are becoming increasingly attractive to global investors. Chart 3 Foreign Holdings Of Securities Are Low Foreign Holdings Of Securities Are Low Chart 4 Falling Inflation Supports The Lira Falling Inflation Supports The Lira Bottom Line: Falling inflation and a narrow current account deficit in Turkey have historically gone hand-in-hand with a less vulnerable currency. This time should be no different: the pace of the lira’s depreciation against the US dollar will likely ease in the coming months.