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Let’s Count All The Ways Steve Mnuchin’s Secret Fed Policy Straw Poll With Bond Dealers Is Absurd

"Ok you guys, show of hands"...

"Ok you guys, show of hands"...
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3 comments on “Let’s Count All The Ways Steve Mnuchin’s Secret Fed Policy Straw Poll With Bond Dealers Is Absurd

  1. Harvey Darrow Cotton

    With a Fed funds rate of an eye watering 2.25% and a Federal Reserve Credit at only $4 trillion, I honestly don’t know how the markets can cope…

  2. The question of faster balance sheet run-off or more rate hikes is a legitimate one because the choices will create a different outcome than the path currently being taken. And the reason this is the case is the $1.7T in Excess Reserves that still remain in the US Federal Reserve Banking system. Since the Fed began drawing down the balance sheet, these reserves have been converting at a better than 1:1 pace into the new Treasury supply being created. Accelerating the balance sheet draw down will probably be no problem as supply of Treasuries seems to still underwhelm latent demand for risk-free assets in the system. The concocted interest rate level (concocted because it is not market determined due to the level of excess reserves in the system, but rater just set and maintained by the FMOC thru the repo market), on the other hand, is a real cost to the economy which is slowing down demand in this credit feed economic monstrosity that was created over the last 10 years (worldwide).

    The Treasury market is already pricing in an interest rate hike pause or cessation in 2019. However,as you note, market supply of Treasuries will continue to increase. A faster Fed balance sheet draw down at this point in time, rather than higher rates, should result in curve steepening as the market will demand a higher price to hold duration as rate hikes pause but supply becomes even greater. There is plenty of room on the long end for rates to push upward and normalize. And, since the Trump Treasury is doing the majority of its current funding of the economic plan on the short end of the curve (even added a 2 Month T-Bill), the market has a much better chance of returning to historic norm levels without an immediate economic recession. On the current path, however, higher short-term rates in the near-term as the long end stays anchored is a recipe for economic disaster triggered by an ill advised Fed rate over-hike path once again – 2000 and 2007,

    A higher long end of the curve will of course have to be digested by the stock market. This will not be without valuation pain. However, the market is currently priced far too high relative to US GDP when compared to historical averages; and the reason for this is that long-term rates are held artificially low by FED, ECB and BOJ policies since 2014. These policies are in the process of reversing, so stocks are going to re-price along with the long end of the curve regardless of the Fed path. Fair value of the S&P500 today is 1800 at a 4% 10 Year and 20T GDP, not 2641 which is the implied bottom being defended today. There is bandwidth in the Federal Reserve system to make a better choice for the US economy at this point in time while meaning the system off the extreme policies of the past 10 years; the Fed rate hike plus balance sheet tightening at the current projected pace is likely to be one that keeps long-term Treasury rates low, but also kills the economy (and blows out corporate credit spreads) over the next year resulting in a 1200 or even lower print on the S&P within the next 2 years. Choose your poison when it comes to equities, but the path is currently lower, not higher based purely on the changes which will be implemented in the world banking system over the next 2 years..

  3. Can you explain the problem you see with the first chart in more detail? Given that IOER is supposed to be a floor for EFFR, I don’t see why the chart is alarming.

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