Fed Says Balance-Sheet Unwind To Start ‘Relatively Soon’
Federal Reserve leaves federal funds target range between 1% to 1.25%.
Fed holds rates unchanged, repeats inflation seen rising to 2%
Fed: labor mkt strengthened, activity rising moderately
Fed: job gains have been solid, unemployment has declined
Fed: household spending, fixed investment continued to expand
Fed: overall and core inflation declined, are running below 2%
Fed repeats mkt-based inflation compensation gauges remain low
Fed repeats survey-based inflation measures little changed
Fed repeats inflation to stay ‘somewhat below’ 2% in near term
Fed repeats risks to outlook appear ‘roughly balanced’
FED FUND FUTURES PRICE AROUND 45% ODDS OF FED HIKE BY YEAR-END
Ok, so obviously the Fed wasn’t going to actually do anything today (much to the chagrin of trader Richard Breslow) so it’s all about incremental information.
It’s worth noting that we did get a rates mini-tantrum following Sintra (so between the June meeting and today) and on the heels of that experience, Yellen changed her tone on purportedly “transitory” inflation in her prepared remarks on Capitol Hill earlier this month.
Those comments were followed immediately by (another) CPI miss in the U.S., further underscoring the idea that the disinflationary impulse may be far from vanquished after nearly a decade of accommodative policies.
The Sintra experience shows just how vulnerable this market is to a rates shock and that only adds to the angst around the balance sheet discussion. Yields moved sharply higher on Tuesday ahead of today’s announcement.
Here’s a brief, annotated history of 10Y yields for context (do note that the June hike came on the same day as another CPI miss, so that’s part of what you’re seeing in the first green shaded box):
Meanwhile, the dollar has steadily declined over the same period, weighed down by gridlock in Washington and a surging euro:
A reminder on positioning: specs were the most short the 2Y on record as of last week, positioning which to some doesn’t make any sense given that there was no chance of hike today…
… but as Deutsche Bank noted, that could well be attributable to the fact that the 2Y is simply too rich, as two Fed hikes have failed to budge 2yr yields by even the smallest amount.
Positioning in 10s is an entirely different story, which makes the whole thing look like a giant bet on further curve flattening. Eurodollar shorts have been pared notably, and as DB also pointed out, “it’s possible that some of the spec shorts in ED futures have migrated to 2yr futures [as] over the last 8 weeks, specs covered their ED short positions by 930K contracts, an equivalent of 23mm DV01 [and] over the same period, spec TU positions went from -19K contracts to -274K contracts, a net selling of 10mm DV01.”
In the dollar, positioning is, well, the most bearish since QE3. Here’s a granular breakdown going back to 2014:
As far as parsing the statement goes, consult your local palm reader lady first (as always) and then maybe skim these tidbits from Goldman and BofAML which we highlighted Sunday:
- We do not expect any policy changes at the July FOMC meeting and expect only limited changes to the post-meeting statement. The statement is likely to upgrade the description of job growth, but might also recognize that inflation has declined further. We think the statement is also likely to acknowledge that the balance sheet announcement is now closer at hand.
- Looking ahead, we continue to expect the FOMC to announce the start of balance sheet normalization in September. We see a 5% probability that the next rate hike will come in September, a 5% probability that it will come in November, and a 50% probability that it will come in December, for a 60% cumulative probability of at least three hikes this year.
- The FOMC is unlikely to significantly change their message at the upcoming meeting. With no Summary of Economic Projections or Press Conference, focus will be on the statement, where we expect the FOMC to tweak the language to emphasize the recent inflation weakness and to double down on balance sheet normalization.
So that’s pretty much everything you need to know as far as background. The highlights are of course here at the outset, and here’s the redline:
Ultimately, my own prediction has proven to be incorrect: