Markets cleared the first of this week’s big hurdles on Tuesday afternoon when Apple earnings produced a relatively benign outcome. To be sure, nobody is particularly excited about that situation, but thanks to the guide down earlier this month, expectations were set appropriately low. “Overall, we did not pick up any signs of either weakness or improvement in the underlying business trends for Apple”, Goldman writes, in their postmortem, adding that the bank remains “concerned that prolonged economic weakness in key markets like China could continue to hurt the company’s performance this year.” Again: same story from a couple of weeks ago, which is about all anyone could “hope” for.
Now, all eyes turn to the trade talks and to the Fed. On the former, Steve Mnuchin tried to paint a rosy picture as he’s inclined to do (he told Fox on Tuesday that he “expects we’ll make significant progress this week”), but that marks a stark contrast to Wilbur Ross’s remarks from last week (“We’re miles and miles from getting a resolution. Trade is very complicated”).
As far as the Fed is concerned, it’s all about the presser and any hints that the pace of balance sheet runoff is set to be tweaked. Last Friday’s WSJ trial balloon seemed to tip that the committee is leaning in the direction of communicating some prospective changes sometime in the not-too-distant future, but generally speaking, nobody expects anything definitive from Powell on Wednesday.
Read more on what’s expected from the Fed
Everything But The Kitchen Sink: Full Week Ahead Preview
As WSJ Tips ‘Earlier-Than-Expected’ End To QT, One Bank Assesses Impact On VIX, Rates Vol.
Obviously, Powell hasn’t been the most effective communicator at times (or maybe he’s been too effective, depending on how you want to look at it) and his newfound adeptness when it comes to pacifying nervous markets will get its first “official” test on Wednesday.
His last two public events went swimmingly, although the market’s fleeting dip when he spoke about the balance sheet in Washington on January 10 was a reminder that spoiled traders will not hesitate to sell at the first perceived communications misstep vis-a-vis runoff.
Read more
It’s All Fun And Games Until Someone Asks About The Balance Sheet
In any event, this seems like an opportune time to remind you that last May, SocGen’s Solomon Tadesse went against consensus to predict that the Fed would only hike three more times.
On Wednesday, he’s out with a new piece, reminding everyone what the rationale was behind that call (which looks prescient now).
“With the June, September and December rate hikes, we believe that we might be at the very end of this monetary tightening phase”, he writes, adding that his forecast “also appears to be validated given the recent backtracking of the Fed from its positions of gradual tightening and the currently increasing consensus view that the Fed instead might pause the rate hikes.”
Those familiar with this relatively straightforward argument know that Tadesse simply points to the fact that while “the Fed funds rate appears very low by historical standards… what makes this monetary cycle special is the massive liquidity injection through QE which drove the implicit true short rate, also called the ‘shadow rate’, much lower than the usual zero-floor of the Fed funds rate.” Depending on the estimate, it may have hit a low of -300bp in 2014.
And that gets to the crux of the matter. Here’s Tadesse to explain (again):
Accounting for the impacts of QE on what would have been the Fed rate absent the zero-bound, we argued in May 2018 that the course of the current tightening was much closer to its top by historical standards, projecting about three rounds of rate increases to reach the peak by December 2018. In fact, adding the current effective Fed rate of about 2.5% to the swift 300bp hike in the ‘shadow rate’ in the middle of 2014, reflecting the winding down of QE, the degree of tightening at present stands at about 5.5%, which is more elevated than the recent cycles (left figure). By contrast, rates went up only by about 4% in the post dotcom tightening cycle of 2000s. Relative to the much deeper easing needed following the 2008 financial crisis, however, the current tightening level is at the average peak level of the last few cycles (right figure).
Again, this isn’t “new” per se, but the fact that SocGen is out reiterating it on Wednesday ahead of the Fed (and the fact that multiple desks still expect at least two hikes in 2019) speaks to the fact that it’s still (highly) relevant.
Importantly, it also underscores the importance of the balance sheet debate, which will obviously take center stage on Wednesday.
