....this is the part I believe the market is being too hopeful, that the Fed would cut rates and wind back so much in 2023. If that would be the case, you'd imagine it would be a severe recession to occur and so bad that the Fed would need to re-prioritise from inflation fight to addressing the recession. Yet, markets are yet to fully impute a recession let alone a severe one. The current belief is that inflation would be defeated down and low enough for the Fed to back off and then start winding back rates once a mild recession unfolds. That is the current belief. Its the glass half full view.
First, inflation could stay protracted for longer that the Fed would simply stay put after raising to 3.5-4% and raising their inflation target to 4% and then allow above "normal" rates to be maintained for longer to do the rest of the job to bring inflation down further. It could cease its QT by then. We could have a recession with "higher than pre-normal" level rates then.
Alternatively, the fragility of markets dictates that even after raising to 3.5-4%, inflation could be beaten down but at the expense of a severe recession that the Fed would indeed expediently cut rates by such quantum of 75bps or probably more. A severe recession would imply a much bigger equity value erosion from where we stand now or even contemplated by bearish market commentators of today.
We don't know where we go from here but the stagflation prospect cannot be discounted. We can be hopeful to a degree but not be in denial of prospects of a worse case we do not wish to contemplate. Given a choice, we'd rather not dwell on the worse case. And that's what the majority would do.
