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The legendary investor Charlie Munger likes to tell a story:
“A teacher asks a class a question: There are 10 sheep in a pen. One jumps out, how many are left?”. Everyone but one boy says 9 are left. That one boy says “none are left”. The teacher says “you don’t understand arithmetic” and he says: “You don’t understand sheep.”

This morning’s better-than-anticipated retail sales report helped boost the Atlanta Federal Reserve’s GDPNow nowcast estimate, with the updated model forecasting a 5.4-percent annualised expansion in real gross domestic product for the third quarter* – joining September’s blowout payrolls report and stubbornly-sticky core inflation data in bolstering the odds on a final rate hike by year end. Treasury yields are soaring.

But we think Jerome Powell and his colleagues on the Federal Open Market Committee understand sheep.

They know allowing groupthink-led markets to run too far in lifting borrowing costs could prove fatal to the global economic expansion, triggering a hard landing of the sort that might endanger the second half of the central bank’s mandate.

As such, it seems likely that we could see a shift in tone over the coming days, culminating in Powell putting more emphasis on downside risks and disinflationary trends during Thursday’s appearance at the Economic Club of New York. Some of today’s price action in fixed income, equity, and foreign exchange asset classes could reverse as a few market participants begin to doubt themselves.

Because how do you get sheep back into their pen? By convincing just one to return.

*This likely won’t match the reported result – the final estimate typically misses the official number released by the government by at least 0.8-percentage points.

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