Nomura’s McElligott Talks Dovish Star-Wishing On Fed Day

The market is abuzz with chatter about exactly what (if anything) Jerome Powell will signal about the future of balance sheet rundown on Wednesday.

Simply put, the market no longer appears willing to overlook the inherent contradiction in pausing rate hikes (let alone cutting rates) and keeping balance sheet rundown on “auto-pilot.”

Powell and a veritable procession of other Fed speakers have been keen to tip a more flexible approach to the balance sheet plan of late, but as we’ve been pounding the table on since the dovish pivot got going in earnest three weeks ago, that’s not going to be enough going forward.

If volatility returns/stocks start to sell off/credit spreads start to widen/financial conditions tighten anew, the Fed will likely need to deliver something more concrete/determinate when it comes to the cessation of runoff if they want to engineer another rally. For the time being, this doesn’t seem too “urgent” with stocks up, financial conditions looser and the dollar down.

(Bloomberg)

Meanwhile, credit spreads have come back in stateside and EM equities are on track for their best month in a year.

(Bloomberg)

Still, the risks are myriad. All it’s going to take to “make risk-off great again” (sorry) is a resumption of gridlock in DC (Wednesday morning found Trump back tweeting about his wall), debt ceiling jitters and/or a “no deal” scenario on trade.

In any event, Nomura’s Charlie McElligott is out with a quick pre-Fed note and there are some notable highlights.

“Some believe it will be difficult for the Fed to not sound somewhat ‘hawkish’ relatively speaking and disappoint ‘doved-up’ market expectations following the recent policy outlook shift (and the ensuing / engineered risk-asset rally) since the Dec meeting, where Committee members have delivered a coordinated ‘patience’ message on further hikes, as well as voiced a willingness to be open-minded regarding balance sheet adjustments due to the potential impact on the economic and market outlook”, he writes, adding that he’s “further refined this dynamic to an even simpler view.” Here is Charlie’s “refined” version:

…it will be difficult for the Fed to get “more dovish”–over even “hold” this current “dovish pivot” from here–without the US data turning lower again…while stabilization of the data in fact brings the “financial conditions tightening” negative feedback loop back “in play,” as Fed tightening re-enters the picture.

That said, McElligott notes what he calls “VERY provocative, 11th hour talk through ‘consultant / macro advisory’ circles that the Fed could in fact state today that at a future meeting, they will lay out an actual timetable to end the balance-sheet runoff.”

That, Charlie writes, would mark “an ‘escalation’ of the thought trial-ballooned in the WSJ piece last week.

Read more

As WSJ Tips ‘Earlier-Than-Expected’ End To QT, One Bank Assesses Impact On VIX, Rates Vol.

Here’s how McElligott imagines the Fed might couch such a communications shift in light of the fact that Powell has variously suggested the balance sheet adjustment hasn’t had any real impact on the outlook for the economy.

By making this purely about “mechanics / plumbing” of the system–i.e. saying that per Primary Dealer surveys / TBAC- type feedback, they have noted the appropriate level of Reserves in the system is ‘X’ trillion for proper function (a number much higher than the generic prior estimates from years-past that the Fed would work to get the balance sheet down to ~$1.5-$2.0T)

He reminds you (curb your enthusiasm) that is “purely his speculation”, but were it to pan out, he notes that “this type of granular commentary on adjustments to balance-sheet would be interpreted as VERY dovish” and it would be “difficult to imagine [it] occurring WITHOUT A COUNTER-BALANCING statement(s)” where that means allusions to the possibility of more hikes, a discussion of how the duration profile of SOMA might look, etc.

In any event, the bottom line from Charlie on the January meeting is this:

There is LOW-DELTA but BINARY RISK into today’s trade–either the first “disappoint the doves” scenario of message sounding more hawkish than anticpated currently with stocks lower as Fed-driven “FCI tightening” remains an ongoing risk, OR this fringe-potential for a very granular DOVISH “end the balance-sheet run-off” market speculation, which could zoom us to 2700-2750 SPX fast.