Janet. Fed Preview

Get ready, Janet’s comin’ in hot.

We’ll get September’s “main event” (so to speak) on Wednesday as the Fed is set to announce the beginning of balance sheet normalization, a move that’s been well-telegraphed but still carries considerable risks for markets for one very simple reason: nothing like this has ever been attempted before.

So far this month, central banks have delivered in terms of moving markets with both word and deed. Draghi managed to thread the proverbial needle (something he’s quite adept at) by simultaneously conveying confidence in the economy, trepidation about the inflation outlook, just enough concern about euro strength to let everyone know he’s aware of what’s going on, and throwing cold water on the notion that the ECB will be any semblance of aggressive on the normalization front. That created a kind of perverse dynamic where yields and FX are negatively correlated as the stronger the euro gets, the less likely it is that QE will end.

Poloz served notice that the BoC is set to roll back the clock to a time when policy makers didn’t have to wait on markets to fully price a rate hike before pulling the trigger. That’s a ballsy move especially in light of the housing bubble in Canada and the still cloudy outlook for crude, but it does make sense considering how robust the incoming data has been. So we’ll see: in about six months ol’ Stephen will look like either the only prudent central banker on the planet or he’ll look like the idiot that hiked ahead of a downturn. Best of luck to him.

Meanwhile, the BoE is having to contend with conflicting signals sent by FX pass through inflation on one hand and wage growth that isn’t keeping up/ Brexit jitters on the other. The hawkish lean we got on Thursday and the followup from Carney and Vlieghe has the pound sitting at a post-Brexit high and the FTSE at a 4-month low. Again, we’ll see how things turn out.

That’s the backdrop against which the Fed is set to give us some specifics about the balance sheet. Here’s Goldman:

Nearly nine years since it first launched Quantitative Easing (QE), the FOMC is widely expected to officially announce on Wednesday the start of balance sheet runoff. We expect the committee to start reducing its reinvestment of principal payments from its securities holdings on October 1st. The Fed plans to limit the shrinkage of its balance sheet in accordance with a previously announced schedule of caps on runoff of Treasuries and MBS. The caps will rise from initial levels of $6bn and $4bn, respectively, to peak caps of $30bn and $20bn in five increments.


We expect the balance sheet to shrink from 24% of GDP ($4.5tn today) to 13.4% of GDP ($3.0tn in 2021) over four years (Exhibit 1).


While the official exit from QE is a significant occasion, the Fed has already communicated extensively about its long-prepared plan for a gradual and predictable runoff. We therefore expect markets next week to focus instead on the outlook for the federal funds rate. The key question is whether the projected path for the federal funds rate declines meaningfully following the surprising deceleration in the inflation data since the start of the year.

Now again (i.e. for the thousandth time), there is no way to know how the balance sheet rundown is going to affect markets. The assumption is that by virtue of the telegraphing (call it Yellen foreplay – now good luck trying to scrub that image from your mind), the reaction will be muted, at least in the near-term.

Assuming there are no fireworks around the balance sheet announcement, then the focus will be on the outlook, which may or may not have been materially impacted by recent events, both political and meteorological. If we assume that the committee will put off worrying about the fiscal picture until December thanks to the debt ceiling deal and if we also assume they won’t be deterred by any noise Harvey and Irma inject into the other data, the focus is squarely on the inflation picture. Here’s Goldman:

Thursday’s CPI report showed firmer-than-expected inflation in August. The core CPI and core PCE year-over-year rounded inflation rates have held steady since the July meeting, at 1.7% and 1.4% respectively. Still, as shown in Exhibit 2, the firmer CPI print in August followed five consecutive misses. As a result, the core PCE and core CPI year-over-year inflation measures are now three tenths and five tenths lower respectively than in March.


How about a summary of recent chatter (“get this through your ‘Brain‘ard”):


For their part, Barclays has the following to offer:

We do not believe the committee will reach consensus on the extent to which slower inflation is transitory and, in turn, how much “patience” is needed before proceeding with further policy rate normalization. Yet, we believe some members will reflect their view that some of the slowing in inflation will be persistent and mark down modestly their inflation forecast for 2018.


We do not expect the median policy rate path to change, but we do expect the average federal funds rate projection to decline. In sum, we do not see the September meeting as the time when the Fed changes tack aggressively in its efforts to get inflation back to 2.0%. Instead, we believe the committee will signal a modestly flatter interest rate path and increased concern, but no more.

So you know, “place your bets.”

To the extent the Fed meeting is serious, we’ll get some comic relief just hours later when the BoJ will tell us that although the combination of cornering the JGB market to the point where it no longer functions and buying up 75% of the Japanese ETF market is working exceptionally well, unprecedented easing is still necessary and will continue for the foreseeable future where “foreseeable future” means “forever” plus however many years on top of “forever” is takes for Kuroda to get inflation to 2%.

Here’s Goldman for whatever it’s worth although at this point, if you’re an analyst, you can just copy and paste your preview of the last BoJ meeting and be almost certain that it will still apply to the next one:

We think the BOJ will maintain monetary policy this week. Specifically, we expect it to keep its targets for short- and 10-year interest rates at -0.1% and 0%, respectively, and make no changes to asset purchase programs for ETF and other risk assets. The BOJ is thus likely to continue taking a wait-and-see stance, keeping an eye on US interest rate hikes.

Let’s see….. what else? Ummm.. just scanning in real time here, it looks like Carney speaks tomorrow which could conceivably provide more impetus for pound strength.

Also we’ll get the Norges Bank on Friday, interesting for reasons you probably don’t care about on a Sunday evening (I’ll write something about that closer to the meeting).

Oh, and Riksbank minutes on Thursday which we presume will include all manner of excuses with regard to explaining why easing is still necessary despite the run-up in inflation (hint: the only explanation you need is that they can’t move until Draghi does if they want to keep a lid on SEK strength).

Good luck out there – your fate rests on the shoulders of a diminutive economist with a pixie haircut…



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