Today is the commencement of the two-day FOMC meeting. I have been in the industry for 3 ½ decades and this is the first time that I can remember a FOMC meeting that has had such a broad estimate of expectations. Some economists’ forecast a 25 bps hike (broad consensus), some for no move (Goldman, Barclays, among others), others for a cut (Nomura) and even a few independent economists calling for a hike of 50 bps.
I guess it is little surprise that the pricing for Wednesday’s meeting has been so erratic. One can clearly see the influence of Powell’s ill-timed speech earlier in the month, which pushed the base case pricing up toward 50 bps, which swiftly unwound two days later with the SVB fiasco.
There is roughly a 50% probability between holding steady and a 25 bps increase, though in quick order the environment may look entirely different.
In almost all regards the proverbial Fed Mantra of avoiding a market surprise has been shattered, perhaps the result of that the FOMC does not know what to do.
The Fed’s primary mandate is to provide financial stability, stability that may have become a more prominent risk.
For all the focus on whether the Federal Reserve is about to pause its interest-rate hikes, there’s another critical policy decision that may draw considerable attention; what the central bank does with its massive pile of bond holdings.
The banking turmoil combined with a previous increase in funding pressures, has left markets keenly attuned to what the Fed may say about its $8.6 trillion balance sheet.
Until this month, the Fed was attempting to shrink its balance sheet back to pre-pandemic levels. But now it has started to expand again as the Fed acts to bolster the banking system through a slate of emergency lending programs.
An argument can be made that financial stability may cause policy makers to slow the runoff of it bond portfolio (QT) that is designed to drain reserves from the system.
Others could argue that even if the Fed does pause its rate increases, the central bank’s overarching goal of taming inflation means it is unlikely it will signal any shift in efforts to shrink the holdings of Treasuries and mortgage debt.
Regardless, the simple fact of the matter is the Fed’s move to backstop banks clearly expands the Fed’s balance sheet. According to Fed data, the various liquidity programs added last week has increased the Fed’s balance sheet by about $300 billion, reversing about half the reduction the central bank has achieved since the runoff began last June according to Bloomberg.
It is often written that life is strange than fiction. The events of the last seven days were entirely unexpected, perhaps at such extremes of occurring only 0.000001% of the time.
Commenting about yesterday’s market action, equites led by the financials rose as banking regulators worldwide rushed to shore up confidence in the institutions. Treasuries across the curve declined in price.
What will happen today?
Last night the foreign markets were up. London was up 1.48%, Paris up 1.61% and Frankfurt up 1.71%. China was up 0.64%, Japan down 1.42% and Hang Seng up 1.36%.
Dow and NASDAQ futures are up 0.75% and 0.25%, respectively on the belief that the worst is over for the financials. The 10-year is off 12/32 to yield 3.56%. The two year is up 8 bps to yield 4.09%.
