Triangulation, Federal Reserve style | Financial Times
FT subscribers can click here to receive Market Forces every day by email.Another interest rate cut by the US Federal Reserve on Wednesday was accompanied by a message that sets a higher bar for a further easing later this year and during 2020.
The Federal Open Market Committee delivered an expected 25 basis points easing that dropped the current Fed funds range down to 1.75 to 2 per cent. Two FOMC members dissented, while James Bullard, president of the St Louis Fed, sought a 50bp easing. The message for markets was hawkish at the margin via the “dot-plot” as the median expectation of the 17 member FOMC for policy over the rest of 2019 and for 2020 is one of no further easing, in effect, stuck at Wednesday’s 1.875 per cent midpoint.Seven FOMC members saw a year-end level of 1.625 per cent for the funds rate (the midpoint of a 1.5 to 1.75 per cent range), while five others see no need for a further reduction. The remaining five officials of the 17-member FOMC expect a funds rate at 2.125 per cent when 2019 ends.Here via TD Securities is a snapshot of the median dots from Wednesday’s meeting and the previous update from June.
Very much a triangulated FOMC, but one seen easing later this year should the economy weaken. That perhaps explains the rebound for Wall Street from its mid-afternoon low. During his press conference, Mr Powell said more extensive cuts may be needed in the event that macro activity slides. That heightens the importance of how US/China trade tension is resolved along with Brexit, and perhaps the most important area of the domestic economy: will the strength of US consumers hold.Jim O’Sullivan at High Frequency Economics noted:”The statement continues to signal optimism but also concern about downside risk because of ‘uncertainties”’. He added: ”While the base case is for little or no further easing, officials are clearly still biased toward more easing because of downside risks.”The market reaction duly saw the dollar rally and equities initially soften. Equities were lower before the Fed statement, with sentiment in part hit by a profits warning from FedEx (See Quick Hits). Gold and oil were near their lows for the trading day late in New York. While a 25bp rate cut was expected, the relative silence from the Fed over further easing, was enough to bolster the dollar.Treasury yields were lower heading into the FOMC statement, while oil trimmed early losses as Saudi Arabia blamed Iran for sponsoring the weekend attacks on oil facilities. US President Donald Trump via a tweet said he had asked the Treasury department to “substantially” toughen economic sanctions on Iran, bolstering the usual havens. The post-FOMC bond market trade was one of a flatter yield curve as two-year yields rose 5bp to 1.77 per cent, reflecting traders trimming rate cut expectations, but another rate cut for 2019 remains priced into the market. The 10-year yield remained flat at 1.80 per cent, after an early drop to 1.74 per cent. That leaves the 2/10’s curve close to a renewed inversion.Beyond the policy outlook, the other big story is this week’s pressure in the short-term funding market that did push the effective Fed funds to the top of its range on Tuesday. That prompted the FOMC to cut the interest the Fed pays on excess reserves to 1.80 per cent, rather than the 1.85 per cent that would have been expected to maintain the target policy. The Fed will offer reverse repurchases at an offering rate of 1.70 per cent, rather than 1.75 per cent. These moves are seen keeping the effective funds rate trading inside the current 25bp target range. Mr Powell said the strains in money markets were stronger than they had anticipated. The Fed chair added that they have the tools to address renewed pressure in the money market and that the central bank will at some stage resume expanding their balance sheet as they assess the correct level of reserves. A second day of overnight repos from the New York Fed saw the full $75bn taken up by the market (demand was $80.05bn). So after $53bn was injected into the repo market on Tuesday, an additional $22bn has been added on Wednesday, and that has helped calm funding anxiety in an important part of the bond market’s plumbing.With the Fed at the ready with such a fire hose via overnight lending operations (a point stressed by Mr Powell), conditions in the repo market should steady, although expect more interventions from the NY Fed markets desk as September draws to a close as it marks the end of the current financial quarter. Such quarterly dates, particularly at the end of the year, are more closely associated with bouts of funding tension.But this week’s eruption in overnight interest rates is seen by the market as a symptom of an underlying issue that has been bubbling away for a couple of years. Upward pressure on overnight market rates tells us that there are not enough bank reserves in the financial system and this outcome was foreseen a couple of years ago, when Lorie Logan at the New York Fed said in May 2017: “Upward pressure on overnight interest rates is the most direct indicator that reserves are becoming scarce.”
The current figure of $1.4tn in reserves appears large, but not once regulatory and liquidity requirements are calculated for banks. That leaves little spare cash for banks to deploy when financing conditions deteriorate like they have this week as companies have pulled cash to pay corporate taxes, a shortfall of cash exacerbated by a glut of Treasury paper that requires financing. The level of bank reserves held at the Fed has declined from $2.9tn in 2014, as the central bank has shrunk its balance sheet and some think the real solution entails the central bank expanding its balance sheet once more. Thomas Costerg, senior economist at Pictet argues:”The Fed needs to leaves a cushion of bank reserves and they will need to resume [Treasury] purchases.”Analysts at Bank of America Merrill Lynch estimate:”The Fed will likely need to purchase $250bn in assets in the secondary market to return to an ‘abundant’ reserve level plus a buffer, and will need to continue outright purchases of ~$150bn/yr to maintain this reserve level. In sum, Fed purchases could be $400bn in the next year.”The resumption of quantitative easing or QE-lite, (the Fed won’t call it that), appears closer than many think. FT.com is free to read for everyone today. If you have a friend or colleague who would be interested in any articles curated here, you can share them widely today.Picture Feedback Thanks to all readers pointing out that Tuesday’s Market Forces picture was not a hawk. Osprey and Kestrel were a couple of views from readers. Doves are not such a challenge for the FT Picture desk.Quick Hits — What’s on the markets radar Transports are seen as barometers for the economy and a profits warning from FedEx has registered with a thud. Blaming a weakening global economy, hampered by an unresolved trade war, the warning from FedEx sent its shares tumbling, down more than 14 per cent at their lows in New York trading. That also left the stock price in negative territory for the year. As the third most expensive share price among the 20 companies that comprise the Dow Jones Transports Average, the tumble in FedEx has knocked the price-weighted DJTA. Not so good for proponents of Dow Theory.Germany finds more buyers for its latest sale of zero coupon 30-year Bunds. The issue was first sold last month when yields were negative and it notably failed to attract enough buyers for the full €1.5bn on offer, with a bid-to-cover ratio of 0.43 times. On Wednesday, a 30-year yielding about 0.05 per cent spurred a bid-to-cover of 0.76 times. Not the full amount, but it’s an improvement. The Bank of Japan meets on Thursday and at a time when the market has begun pricing in a 10bp rate cut for the current overnight rate set at minus 0.1 per cent. While the BoJ is expected to keep policy steady for now, a more dovish tilt looms with both the European Central Bank and Fed in easing mode. Further gains in the yen do present a problem for Japan and any bout of renewed risk aversion in the next couple of months that triggers a stronger currency will increase the pressure on the BoJ.UK consumer inflation moderated during August and ran at its slowest pace since late-2016. Consumer prices were 1.7 per cent higher for the year to August, after climbing 2.1 per cent over the past year to July. That may well be seen as temporary good news by the Bank of England as wage growth has been picking up sharply of late. But as the BoE meets on Thursday, the debate over policy remains very much a hostage to Brexit outcomes. Your feedbackI’d love to hear from you. You can email me on firstname.lastname@example.org and follow me on Twitter at @michaellachlan.