The Federal Reserve may be heading toward its most uncomfortable policy setup in years — and markets are underestimating the implications, according to macro strategist Alfonso Peccatiello.
Peccatiello — founder of The Macro Compass and a former ING portfolio manager — warned that U.S. inflation is quietly reaccelerating even as the Federal Reserve lacks the political will to raise interest rates again.
The money market currently assigns a nearly 70% chance of a 25-basis-point rate hike by year-end, according to the CME FedWatch tool, which tracks Fed futures.
“The standard reaction function from the Fed should be to move to hikes… [but] the Fed is unlikely to have a majority actually voting for hikes any time soon,” Peccatiello said.
The Economy Underneath The War
Strip out the energy shock, Peccatiello indicates, and what remains is an economy accelerating. Inflation-adjusted government spending is running hotter than in 2024 and 2025, and the debt-funded artificial intelligence build-out is pumping credit into the real economy.
The labor market, in his reading, has found a floor – a weekly hiring gauge has swung from roughly 50,000 job losses last summer to about 42,000 in additions today.
With the supply of new workers near zero, it does not take much demand to restart a virtuous cycle.
The Fed’s Problem: Inflation Is Too High To Cut, But Politics Make Hikes Difficult
The textbook response to a reaccelerating economy with building price pressure is to raise interest rates. Here is where Peccatiello’s argument turns.
A rate increase, he writes, needs a majority of the 12-member rate-setting committee. By his count, the votes are not there: the new leadership led by Fed Chair Kevin Warsh has leaned dovish, and a genuine pro-hike majority is unlikely to form, even if the data screams for one.
As Peccatiello noted, Warsh has discussed balance-sheet reduction as an alternative to rate hikes and floated the idea of focusing on trimmed-mean inflation metrics instead of core PCE inflation.
“There are 12 voters, and a 6-6 situation gives the FOMC Chair the power to break the tie,” Peccatiello said.
“It’s safe to say Warsh would rather eat his hat than raise rates,” he added.
Where To Invest In This Economic Regime?
Peccatiello says a 40-year backtest of this setup – accelerating growth, easy policy, building inflation – points consistently to the same winners: high-beta equities such as small caps and emerging markets, high-beta commodities such as silver, copper and gold, and steeper yield curves.
The market is not positioned for it.
He recounts presenting the thesis to three large macro hedge funds in London and meeting outright disinterest in gold and in small-cap and emerging-market stocks.
On Tuesday, the Russell 2000 Index – as tracked by the iShares Russell 2000 ETF (NYSE:IWM) – soared to fresh record highs, propelled by blowout rallies in several tech-linked small caps.
Yet, both the SPDR Gold Shares (NYSE:GLD) and the iShares Silver Trust (NYSE:SLV) remain 15% and 19% below their all-time highs reached earlier this year, respectively.
Peccatiello warned, however, that the thesis depends heavily on energy markets stabilizing and the Strait of Hormuz remaining open.
“If we unlock energy flows, we will Run It Hot,” Peccatiello wrote. “And the market is not fully prepared for it.”
Photo: Shutterstock
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