By Karen BrettellApril 9 (Reuters) - The forward curve of swaps based onFederal Reserve rate expectations has inverted slightly,indicating that market participants are concerned about the U.S.central bank making a policy mistake, analysts at JPMorgan saidin a report.The forward curve of the one-month overnight index swap(OIS) rate has inverted slightly after the first quarter of2020, implying an expectation that the Fed will cut rates afterthen, JPMorgan said in the report sent on Friday."An inversion at the front end of the U.S. curve is asignificant market development, not least because it occursrather rarely. It is also generally perceived as a bad omen forrisky markets," analysts including Nikolaos Panigirtzoglou said.The two most likely explanations for the inversion is thatmarkets are pricing for a Fed policy mistake, or for end ofcycle dynamics, with a central bank mistake seen as more likelybased on fund flows.Flows into equity funds have turned slightly negative, aftera strong start to the year, and interest rate sensitive sectorsincluding real estate investment trusts (REITs) have seenoutflows, which supports the hypothesis that investors areconcerned about Fed policy.Government bond exchange traded funds (ETFs) have also seensteady inflows while inflows into inflation-linked governmentdebt ETFs have slowed, adding to the idea that there is concernabout a central bank error. Concerns about Fed policy would show as fears about earliergrowth weakness and be marked by weak equity flows, greaterflows into longer-dated bond funds than shorter-dated ones andweak flows in interest rate sensitive sectors.End of cycle dynamics, on the other hand, would be reflectedas overheating and inflation fears, which would boost flows intoinflation-linked funds, shorter-dated bond funds and intocyclical sectors and equity funds in general.Supporting the end of cycle thesis is that recent equityinflows have focused on cyclical sectors and outflows have beenin more defensive sectors, and that inflows into short-term andfloating-rate bond ETFs have outpaced those of long-term bondfunds, JPMorgan said. (Reporting By Karen BrettellEditing by Chizu Nomiyama)
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