The Federal Reserve should have started raising rates a year or two ago–we all knew it–but they insisted on waiting until last month to do the deed.
Now they are raising rates and even the most dovish of them is advocating for strong rate increases and even an immediate move to reduce the size of the balance sheet.
Hearing Fed Governor Brainard’s speech yesterday was a joke–for years she wanted low rates and pump, pump, pump. Now she sounds like the biggest hawk. What the hell happened to ‘data dependent’?
So anyway we have the FOMC minutes released in about an hour. We had 1 Fed governor speak already today and we have 2 tomorrow–including Bullard-the biggest hawk of the hawks.
Hang on–we’ll get these clowns done with and then get back to letting markets decide where to go.
22 thoughts on “The Clown Show Continues”
An interesting on this topic in this week’s Barrons – https://www.barrons.com/articles/fed-balance-sheet-reduction-51649446320?mod=hp_LEAD_3
Only Half of the Fed’s Tightening Is Priced In. What to Know.
By Lisa Beilfuss
Updated April 9, 2022 2:34 pm ET / Original April 8, 2022 3:32 pm ET
The Federal Reserve is about to begin unwinding its balance sheet for the second time after the financial crisis, but this time the process will start sooner.
The Federal Reserve is about to start shrinking its massive balance sheet. Officials say the process will run in the background, but it probably won’t. Investors should brace for an extended period of uncertainty and volatility.
When the central bank released minutes this past week from its March meeting, it suggested that, in May, it would begin unwinding some of the trillions of dollars in pandemic bond purchases it made over the past two years. That would be lightning-fast, given that quantitative easing just ended. The last time the Fed conducted quantitative tightening, or QT, it waited two years after interest-rate liftoff to shrink its balance sheet. Its newly suggested plan would amount to double policy tightening—half of which investors might be missing.
We know that policy makers would have raised rates by a half-point in March had Russia not invaded Ukraine, and the meeting minutes and recent Fedspeak suggest that many officials favor at least one 0.5% increase at future meetings. Traders are pricing in 80% odds of a half-point rise in May and a 50% chance of another in June, according to CME data.
But QT is not even close to being priced into markets, says Peter Boockvar, chief investment officer at Bleakley Advisory Group.
It makes sense that more attention is falling on rates than balance-sheet reduction. Whereas economists, market analysts, and corporate executives can easily model for interest-rate changes, QT has happened only once before. And, as Boockvar notes, it occurred at a glacial speed. Investors have new details about how the Fed intends to handle its $9 trillion portfolio—which has doubled since the start of the pandemic and represents roughly 40% of gross domestic product—but how that ripples through the economy and markets is the great unknown.
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As Fed Chairman Jerome Powell put it earlier this year, “I think we have a much better sense, frankly, of how rate increases affect financial conditions and, hence, economic conditions. [The] balance sheet is still a relatively new thing for the markets and for us, so we’re less certain about that.”
Here is what we know so far: The Fed signaled that it would let its balance sheet run down by $60 billion in Treasuries and $35 billion in mortgage-backed securities a month, ramping up to that pace over three months. It will let these maturing securities roll off, instead of reinvesting the proceeds.
That’s easy enough on the Treasury side of the portfolio, at least for the next year or so. Boockvar notes that about a fifth of the Fed’s $5.8 trillion in Treasury holdings mature in a year or less, and about 30% of that chunk will do so in less than three months. And Barry Knapp, director of research at Ironsides Macroeconomics, says that the roughly $4 trillion in bank deposits and another couple of trillion in cash parked at the central bank means it will take at least a year to soak up excess liquidity.
It’s much trickier on the mortgage-backed securities side. Part of the problem: As rates rise, prepayments fall. That lengthens the duration of the Fed’s MBS holdings, limiting the short-term natural runoff. In November 2021, the conditional prepayment rate was roughly 30%, data from S&P Global show. If prepayments slow to a 10% rate—as they did at the peak of the 2017-19 tightening cycle—MBS runoff would average about $20 billion per month, says Jefferies chief economist Aneta Markowska. That is well below the $35 billion cap the Federal Reserve has signaled, and it means that it would have to sell roughly $15 billion in mortgage-backed securities a month to meet its target.
Not long ago, the idea that the Fed would sell MBS was shocking. Now, Wall Street thinks outright sales won’t happen until 2023 at the earliest; Boockvar says it will be much sooner.
Here’s what else we know about QT. While rates more directly touch demand, quantitative operations more directly affect asset prices. QE significantly boosted those prices as the Fed bought, and investors should expect a symmetrical result with QT, though the Fed won’t fully reverse its pandemic purchases. Boockvar says that each $1 trillion in QT equals about 0.5% in additional tightening. But how far will stocks and home prices fall? No one seems to know.
Of the other known unknowns, here are a few to ponder:
When the Fed sells MBS, there will be buyers, including banks, insurance companies, and pension funds, says Joseph Wang, a former senior trader on the Fed’s open markets desk. But he notes that over the next several years, about $2 trillion in QT is going to overlap with historically high Treasury issuance. That means a lot more supply for investors to absorb, even before MBS sales. And, Wang adds, recent fund flows suggest waning demand for Treasuries. “Even the most ardent bond bulls will not have enough money to absorb the flood of issuance, so prices must drop to draw new buyers,” he observes. So, how far will prices need to drop, and how high will yields need to rise?
Then there’s the impact on housing. How the Fed handles the MBS unwinding is crucial to what happens to the overall economy. The central bank must cool the housing market, which makes up 40% of consumer price inflation and a fifth of GDP. But what happens when demand slows but prices still rise because of low inventory?
And finally, when the central bank sells MBS, it’s likely to do so at a significant loss. Who will eat it?
The Fed this past week gave more QT details than many strategists had expected. But there are still more questions than answers, with investors and policy makers together in the dark.
Looks to me like we’re going into recession. Transports have been falling, yield curve inverted and fed is raising rates, which they only do once recession is already here. Fed will have to cut to zero again. Always wrong….always late.
An even more poignant and disturbing prediction from PGIM. That rates will be back to zero again in 3-5 years. And while the Fed hasn’t even started to raise rates yet The Market is already pricing in rate cuts 18 months out. It screams duration to me….or maybe it just makes me want to scream.
Still all talk and no action. They’re over a year late. They’ll have to overdo it to accomplish anything now. Throwing us into a recession to fight inflation they caused. After which they’ll have to cut rates. After the fact as usual.
1Q 22 Commentary from my small-cap manager said it best:
“Meanwhile, financial assets have shot to the moon. Astonishingly, the Fed’s reputation, which should be in tatters, remains sterling across the upper socioeconomic class, who frequently turn a blind eye to the destructive long-term effects of Fed policies.
Absurdly, Chairman Powell is being compared to Paul Volcker because Powell reluctantly raised rates 25 basis points and promised more. The last time inflation was registering in the high single digits, the Fed funds rate exceeded the CPI and you could earn a positive real yield on a bank CD.”
The CD yield vs CPI was positive BEFORE taxes, but never after taxes in my experience in the late 70s and early 80s.
I think this interview with Former Fed Governor Dudley on Bloomberg today kind of touches on all the comments and concerns. I’ll just leave it at that.
Oh lord…we’re in for a h*ll of a bumpy ride!
I am concerned that a new and fourth mandate will arise by the end of the year: avoid creating such a large interest bill on the national debt that the media and Congress have to pay attention. Raising rates when the national debt exceeds $30 B seems fraught with political risk. Does the Fed have the guts to raise rates more than 200 basis points and say damn to the budgetary consequences?
Should be $30T not $30B. 2% rate increase is $600B above current payments. Not an adult to be found. Devalue, devalue, devalue is all they can stomach.
I fall to the obvious!😁
haaa, those tax deductions for CY unrealized losses (the flip side of planned taxes on unrealized gains) are on track to be galactic
This is actually a historic moment in the span of the last 40+ years. At some point, prob before Summer starts, some official obit will be posted for the death of the Great Bond Bull.
Yes, the show, with all the clowns went on, but the main act is not going to show for the crowd, the crier will proclaim, “The King is dead…long live..” well you know how America works.
In lieu of the hype and ticket sellers I hope everyone has positioned themselves for the next three to ten years depending on your need for exciting entertainment or secure boredom.
The next global generation is also going to be silently handed the baton as well. I just hope the music is as good!
Remember back if you are old enough, to all of the changes we witnessed, names, cherished ideas, financial maxims…could be just as “interesting”.
I am glad to have found this group and Tim’s site which challenged and has been tempered into my mettle (pun intended).
Best of Skill to All here. JA
Tim, as you have said in the past few months, this is a total mess.
The misfits at the Fed think they control something that is controlled by factors beyond their control.
If they are more concerned about the stock market and elections (which they are) than the rising cost of living then they have a conflict of interest.
The only thing we can do is keep posting as a community and try to take advantage of this situation.
It’s a mess.
In the end what the Fed is trying to is throw a car out of a plane and land it in a parking spot. The dual mandate of the Fed creates competing priorities; this is an unfortunately reality we have to accept. Which is why the Fed will, at times, come off as being contradictory. Just buckle your seatbelts and hope you don’t get too banged up on impact!
Many close observers think the Fed has a triple mandate, NOT a dual mandate. In addition to inflation and unemployment, the third mandate is stock prices. Does anybody around here really think the Fed IGNORES stock prices? Do you think the Fed would sit idly by if the SP500 drops say 50%? It would invalidate a lot of the “wealth effect” they have counted on since the GFC in 2007-2008. Go back and read Bernanke’s original piece touting the wealth effect.
Presumably they cannot meet the triple mandate with the current cards they have. So the question is how will they balance all three out?
As I have stated many times for many months, my personal highest probability outcome is for higher interest rates and LOWER prices on ALL preferreds in general. Obviously exceptions exist, but you better pick carefully or should I say luckily.
BTW, I used to know a voting member of the Federal Reserve board and he/she would privately agree they had a third mandate.
The third mandate is financial conditions, not stock prices. Loosely this translates into access to capital for high yield companies. In 2018, there were a couple months in which there wasn’t a single high yield bond issuance and credit markets were frozen. However, there’s a strong relationship between that and stock prices.
Tex, I think its pretty fair assumption must people would see agreement in your post. And I, personally, especially like your word probability as certainty is never a given.
That being said there is to some degree baskets of preferreds and a preferred market in general. Sparing the blah blah details mentioned many times, issues like say RMPL-, TECTP, and PSA-J as examples (company risks aside) will in time could very well trade in different manners just because of the varying types of preferreds they are.
Tex…If memory serves me correctly, I believe I saw a clip of Powell a few months back, where he said something like ” elevated equity and real estate valuations pose a risk to financial stability”, like he didn’t want them too low or too high. Was kind of bubbly for awhile there
Fed is a bank regulator with a dual mandate employment / inflation.
Employment has been solved. Inflation is going to be squashed like a bug.
Majority of markets and behaviors surrounding it are based on psychology. Stating something multiple times in different ways will lower inflation all by itself.
Your comment is very astute. IMHO, the Fed is incapable of solving inflation: if they could, they would have done so already (or have made good strides towards it) and be basking in the glory.
Instead, even in October, when CPI was high for a few months, they were inactive. Soon thereafter the rhetoric machine picked up and it was all about how tough they were going to be – but still no action. No inter-meeting hikes, basically nothing for the 4 months of tough talk.
Finally 3 weeks ago: action! It was the tamest response they could have. 25 bps increase on a Fed meeting. After the markets rally on the rate hike, it is back to talking tough (7 rate hikes this year and such). The Fed wants the market to change its attitude: that will raise rates and hopefully stop the inflation problem.
All of them are smart folks at the Fed. So it makes me wonder what were the real reasons for their lack of action. They obviously knew congress giving out free money and keeping rates low would cause this to happen. So I guess they thought they were stimulating the economy out of the stall it was in during covid due to our very own actions nation wide. A self inflicted wound in many ways world wide which went from two weeks lock down to “slow the spread” to multiple months of many biz types being forced to shutdown.
But once past that… why did they not act? Transitory was obviously not pretty early on unless transitory is defined as multiple years if you have a longer view. But even if transitory slowly raising rates back then would have been prudent if telegraphed clearly.
I just feel like i do not know the real reasons. The reasons you read about in a book a decade later when their careers are over and can talk more freely.