Federal Reserve officials have very nearly written our letter for us this quarter. Earlier this year we worried economic data were increasingly at odds with the Fed’s policy stance, a conflict that would eventually result in a sharp change in tone from the central bank.

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A new interest rate cycle is upon us. The Fed has said – and the market is largely in agreement - that within a year short-term interest rates are likely to rise. We have already spent considerable effort purging interest rate risk from portfolios.

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One perplexed Fed watcher recently observed that “Fed policy. . .is maddeningly disconnected from their [sic] forecasts.” After all, how can the Fed legitimately be concerned about unemployment and low inflation while simultaneously winding down bond purchases?

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We have expressed concern for some time that markets have been too sanguine about the eventual ‘lift off’ from zero rates, ignoring a recurring Fed narrative that has attempted to guide toward an earlier exit should economic progress (as narrowly defined by the unemployment rate and inflation) justify it.

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Unemployment and inflation generally work against each other. The Fed was counting on that relationship holding up when it established a dual threshold based on those indicators in late 2012. The idea was that as the two converged (or diverged), markets would better understand the future direction of monetary policy and adjust accordingly.

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At Rain we talk a lot about what we call ‘information days,’ brief periods of time that are extremely rich with information. We find that evaluating narrow time periods of isolated stress (or euphoria) can be just as informative about manager positioning and underlying risks as longer-term statistics, if not more.

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