Donald Trump’s cartoonish calls for a “like one point” rate cut and a restart of “real” QE aside, there are some actual, front-burner policy debates going on right now and the market will be looking for clarity from today’s Fed statement and Powell presser.
The Fed is clearly worried about disappointing dovish expectations and the President’s tweets aren’t helping.
Even if you don’t believe Trump’s signature balderdash is impacting the Fed’s decision calculus (and it is, by the way), the fact that he continues to draw the public’s attention to monetary policy itself creates extra pressure because it raises the chances that any perceived hawkish lean will catalyze an adverse reaction in markets. If you don’t believe that’s the case, see December.
On Wednesday morning, ahead of the Fed, Nomura’s Charlie McElligott is out with some commentary on the debates that are in fact “live”, although, again, implicitly suggesting that some kind of overt dovish lean on the actual policy rate and/or the balance sheet is far-fetched is to underestimate Trump’s ability to influence the central bank. If we’ve learned anything over the past six months, it’s that nobody should underestimate Trump’s penchant for pushing the envelope until somebody (in this case Powell) folds.
But getting back to McElligott and “urgent” policy discussions, he talks quickly about the IOER debate, which has of course been simmering since last year’s “tweaks”.
“Let’s get this out of the way first: a ‘technical’ IOER adjustment of 5bps at today’s FOMC meeting is ‘trending’ pretty hard right now (which is absolutely a de facto rate ‘cut’ — just not the policy rate), going from what I’d estimate as a 20-25 delta market probability say last Friday to what I now believe is probably an even 50d ‘market expectation'”, he writes, before tying those expectations to the dollar’s recent pullback. “[This] is totally rational in the context of my recent point that the recent April ‘funding stress’ escalation was a core driver of the USD (DXY) breakout to fresh 2 year highs”, he says.
If you ask Charlie, the next IOER tweak will come in June, although he does acknowledge that it’s a close call due to the above-mentioned fear of disappointing the market.
Those fears aside, McElligott says he’d “expect to see a modest easing of funding stress following the month-end turn away from April’s idiosyncratic ‘gap lower’ in bank reserves due to tax payments, which should then naturally / gradually pull the O/N rate modestly lower upon reversion, thereby buying time for the Fed’s ‘later’ implementation at start of Summer.”
With that out of the way, Charlie weighs in on another hot topic. He calls the risk of a hurried standing repo facility announcement “nonexistent” (due to the time needed to consult markets and work out the details), but he notes that “any ‘constructive’ mentions of ‘standing repo facility’ would then be perceived as BULLISH for risk assets from an overly-simplistic ‘+ LIQUIDITY / EASING’ perspective which risk assets cheer.” Here’s a key passage on this from McElligott’s Wednesday note:
The facility too would likely be used to (theoretically) reduce demand that “shrinks” reserves (just by “being there”—doubtful it would receive much usage), as the desire from banks to hold “precautionary” balances for liquidity regulation purposes “…would be significantly curtailed if the Fed made available a standing repo facility that offered a lower lending rate and stood ready to accept U.S. Treasury securities at little or no discount” (St Louis Fed )–As “voodoo or not,” market perception of both 1) the absolute level of- and (most importantly) 2) the trajectory of- reserves was an obviously massive-input in last year’s QT / FCI “tantrum” (excess reverse growth in QE as a “market positive,” reserve shrinkage perceived as “market negative”)
Charlie is also looking for any update on the Fed’s plans for balance sheet composition.
Obviously, the market is anxious to know when WAM will be actively shortened (i.e., a reverse Operation Twist in the interest of freeing up room for a sequel to the original Operation Twist later on down the road).
As far as the curve is concerned, McElligott says that “whether we see a bull- or bear- steepener today [is] a tough call, because we all expect the Fed to reiterate their ‘patient’ call despite them more-than-likely upgrading their economic assessment (“bear”), while too we see positioning continuing to iterate the VERY crowded ‘long’ in Rates / USTs”, which then raises questions about who the marginal buyer is at this juncture. If there isn’t an incremental buyer, that’s also a potential bear steepener catalyst and any bear steepening would likely play into the nascent “cyclical reflation” narrative (at what point can we drop the “nascent” adjective?).
Here’s a bullet point update on Treasury positioning:
- JPM Treasury Investor Survey out yesterday shows US investors most “net long” longer-dated USTs since Jun 2016
- Nomura QIS CTA model estimates that the $allocation to TY is back again nearing 2.5 year highs at +1SD relative to positioning since 2010
- Nomura QIS Risk Parity model estimates that the $allocation to TY long is +2.5 SD’s relative to all positioning since 2010, and at 9+ year absolute highs
On the bull steepening side, Charlie writes that if the Fed “were to hit markets and yet again come off as ‘more dovish’ that expectations, expect the bull-steepener to party as it has since October.” Bull steepening could result from the Fed emphasizing the following things, some of which we’ve been over extensively this week:
- Overemphasize their still-growing concerns around the trajectory of core inflation in April / May
- Still voicing support for an “insurance cut” (Clarida referencing ’95-’96 cuts around weakening prices—or even the ’98 ‘external’ factors of EM- and LTCM-)
- Mentions of tighter USD-funding conditions (i.e. the FF Effective through IOER discussion)
So that’s a quick primer on what to watch if you’re interested in nuance. You can count the president among concerned parties who are not interested in nuance, which means the only thing the White House is going to care about is “on hold” and where the Dow closes (because it’s not clear Trump knows what the S&P even is).