April 7, 2022

Markets Today: Fed to slash balance sheet sooner rather than later

FOMC Minutes reveal plans for much faster and more aggressive balance sheet reduction than 2017-2019

Today’s podcast


Overview Eve of Destruction

  • FOMC Minutes reveal plans for much faster and more aggressive balance sheet reduction than 2017-2019
  • New sanctions against Russia agreed but (so far) still excluding energy products
  • Is ‘demand destruction’ becoming a thing? (Oil off 5%, Copper -1.5%)
  • AUD back to ~0.75 on stronger USD, lower commodity prices, falling stocks

This whole crazy world is just too frustratin’, And you tell me over and over and over again my friend, Ah, you don’t believe we’re on the eve of destruction – (Barry McGuire, 1965 – A protest song about political issues of the ’60s, which many radio stations refused to play. It went to No.1 in the US and No.3 in the UK)


US yields have pushed higher, more so at the longer end of the Treasury curve, in moves that came in front of FOMC Minutes which quantify the extent to which the Fed’s balance sheet will shrink ($95bn per month) and how quickly these monthly caps will be reached (3 months). This has lent fresh support to the USD while maintaining downward pressure on stocks. Together with sharply low oil prices (-5%) the AUD is the weakest performing major currency overnight, dropping back to +/- 0.7500 having been as high as 0.7661 on Tuesday.

Minutes of the March FOMC meeting released a couple of hours ago reveal that “many participants would have preferred a 50 basis point increase in the target range for the federal funds rate at this meeting”, had it not been for the uncertainty triggered by the war in Ukraine and that “many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified.”  This section following a discussion at which “Many participants indicated that their business contacts continued to report substantial increases in wages and input prices that were being passed through into higher prices to their customers”.

On the balance sheet, while not explicitly mentioning May as the start date for the commencement of Fed balance sheet unwind, the Minutes note that  “All participants agreed that elevated inflation and tight labor market conditions warranted commencement of balance sheet runoff at a coming meeting (singular) with a faster pace of decline in securities holdings that the 2017–19 period. It was generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate, to be phased in over a period of three months or modestly longer if market conditions warrant.” In 2018-2019, recalls, the monthly caps for the balance sheet maxed out at $50bn, a rate that was only achieved a year after the process of balance sheet reduction commenced.

The Fed’s intention with regard to the balance sheet are very much as flagged by Fed Governor Lael Brainard in her speech on the eve of the Minutes, though she didn’t pass comment on the ‘50bps or 25bp’ question. As such, the peaks in US Treasury yields overnight came well ahead of the Minutes’ publication, 10s to a new cycle high of  2.66% and 2s 2.60%, since when yields have eased back to 2.50% (2s) and 2.60% (10s) so slightly extended the curve re-steepening trend evident on Tuesday. The net rise in US10s (5.6bp up on Tuesday’s NY close) has been roughly matched in Europe where Gilts finished 5bps higher, Bunds +3.5bps and peripheral Eurozone bonds as much as 8bps (Greece). On the latter, in reported comments yesterday ECB chief Economist Philip lane spoke about avoiding ‘fragmentation’ in the Eurozone market, a hint that the central bank might look to lend support to the Euro-periphery even after ceasing its APP bond buying scheme and starting the prices of normalising monetary policy.

By way of proof that US yields matter more for currencies than yield moves elsewhere – other than in the context of moves in relative curve shapes – the USD has drawn a bit more support from the latest move up in Treasury yields , the DXY index +0.15% to a new cycle high of 99.77. This is even though two of the DXY index big hitters, EUR and GBP, are little changed on 24 hours ago. It is a slightly weaker JPY (-0.15%, due to higher Treasury yields) and CHF, CAD and SEK that have driven the moves here.  Commodity linked currencies  in contrast are all substantially lower, NOK and NZD both by around 0.5% and AUD down 0.9% to an overnight low of 0.7496 (0.7510 as of now).

The fall-back in AUD/USD looks to have been on a combination of the deterioration in risk sentiment (e.g. the VIX up to nearly 5 from sub-19 on Monday, currently 22) and smartly lower oil prices, so a reversal of two of the key drivers of AUD strength in recent weeks. WTI crude is currently off 5.0% and Brent 4.9%. Here, the newly announced sanctions on Russia overnight include measures which will prevent any US entities from transacting with two large Russian financial institutions, Sberbank and Alfa-Bank and also sanction more individual with links to the Putin regime or who are family members. Pointedly though, there is nothing as yet on Russian energy sales (where the buzz earlier in the week was that coal imports might be banned by EU member states). Also to note is that the International Energy Agency (IEA) said it will deploy 60 million barrels of oil from its emergency stockpiles alongside the US’s planned 1 million barrels per day 9180 million in total) SPR release. This is on the high side of the chatter either side of the weekend (30-50 million barrels). IEA data overnight also showed US crude stockpiles rose by more than  million barrels last week.

Whether there is an element of ‘demand destruction, or fears thereof, in the fall-back in oil, including from fears over what the pace of Fed tightening might do to the US economic picture or the ongoing lockdowns in Shanghai is unclear, though yesterday’s sharp fall in the Caixin Services PMI (42.0 down from 50.2) suggests there might well be, in which respect note copper prices are off 1.4% overnight.

The lower AUD means in effect that the bounce following the shift in RBA rhetoric evident in Tuesday’s post meeting statement has fully reversed, confirming that limited role that interest rate factors are playing relative to commodity prices and risk sentiment. On rates though, appearances from RBA Deputy Governor Michelle Bullock, and Chis Kent, late yesterday did nothing to undermine the message that rate rises are not far off. Bullock said that Australia has a ‘very tight’ labour market and that the RBA is starting to see wages outside fixed agreements quicken and that she sees underlying inflation pressures in the economy we are stating. Kent said the RBA is hearing on the ground that wage pressures are building.

US equities have closed with the NASDAQ off just over 2% and the S&P 500 down 1%, so IT – as well as consumer discretionaries – leading the S&P lower, while energy (+0.5%) is somewhat surprisingly up despite the fall-back in oil prices. Utilities are the biggest gainer though, +2%.

Coming Up

  • Not a big data ahead on the scheduled data or events calendar. Locally, we get the February trade figures, where exports are seen unchanged on the month after the 8% January jump, with imports seen up 2% after being down 2% last time. Overall trade surplus seen A$11.65 after January’s near-record $12.89bn.
  • Offshore, German industrial production (0.2% m/m expected for 3.7% y/y up from 1.8%), Eurozone retail sales (seen 0.5% for 4.9% y/y down from 7.8% in January) and in the US just weekly jobless claims (200k expected after 202k last week).

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