2017/07/26 Commentary: Balance Sheet Backlash?
© 2017 ROHR International, Inc. All International rights reserved.
Extended Trend Assessments reserved for Gold and Platinum Subscribers
Commentary: Wednesday, July 26, 2017
Balance Sheet Backlash?
There doesn’t seem to be much of a chance the FOMC will hike rates today, and no chance it will lower them. As such, the ‘statement only’ announcement release at 13:00 CDT (14:00 EDT, 18:00 GMT) is what we classically refer to as an interest rate ‘non-decision’ meeting. The grounds for the Fed to reverse its recently renewed misguided ‘normalization bias’ were well covered both before and after Chair Yellen’s less hawkish Senate testimony on July 12th. In the context of the still quite hawkish June 13-14 FOMC projections and press conference, her indication that the rate hike cycle is likely close to ending was quite a shock to many folks. Yet not for those who were studying the true nature of the US employment situation.
Our extended view along with many links out to qualified sources on the real nature of US and global employment and inflation are still available in last Thursday’s Commentary: ‘Normalization Bias’ NOT Back Redux and the previous (post-Yellen testimony) Commentary: ‘Normalization Bias’ NOT Back!! post. We encourage anyone who has not reviewed those posts and especially the very informative access to estimable outside sources to still do so. It’s very good insight on ECB psychology as well as the Fed.
And one who has a consistently realistic view of all the central banks for years is Yra Harris in his Notes From Underground blog and communications in various other venues. So it was no surprise that last week Wednesday Yra was adamant that there was no chance the ECB (or the BoJ) was going to signal any move toward less accommodation. That was in the face of many who felt Mario Draghi’s economically upbeat June 27th ‘Sinha’ speech signaled the beginning of ECB tightening. Of course, as we noted in our posts both before and since, this was a misinterpretation of what Draghi was really saying (see last Thursday’s post for much more on that.)
Yet prior to his exploration of why the ECB and BoJ were definitely going to remain more accommodative than some suspected, Mr. Harris went into why the FOMC might surprise in today’s ‘statement only’ decision with more definitive information on the Fed’s plan to shrink its balance sheet. You can read his open source The BOJ and the ECB Provide the Recipe For … ????? post which opens with his thoughts on that.
Authorized Subscribers click ‘Read more…’ (below) to access balance of the discussion. Non-subscribers click the top menu Subscription Echelons & Fees tab to review options. As this is a ‘macro’ assessment, Market Observations remain the same as last weekend’s update (lower section) of last Thurday’s Commentary: ‘Normalization Bias’ NOT Back Redux post, and there is no Extended Trend Assessment in this post.
NOTE: Given the likelihood the US economy will now get the structural reform that we (along with Mario Draghi and others) have been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015, we need to adjust our view that a potential economic and equity market failure is coming. We previously referred you back to our December 8, 2015 post for our major Extended Perspective Commentary. That reviewed a broad array of factors to consider Will 2016 be 2007 Redux? While a continued regime of higher taxes and more regulation (i.e. under Clinton) might have fomented a continued weak or even weaker US economy, the tax and regulation changes proposed by the Trump administration will hopefully still be approved by the Republican Congress and diminish the similar fears we had to what transpired in 2007-2008.
▪ This might still seem a bit strange in a ‘statement only’ announcement. That is due to the tendency of the markets to sometimes misinterpret what they hear from the Fed officials that then needs ‘adjustment’ with a follow up communication. Yet along with it being his sentiment, the ideas Yra shares are from credible sources. Most tellingly the markets have already been well-prepared for balance sheet reduction, and waiting until September runs into the problems that might flow from the US Congress addressing the debt limit before funding runs out in October.
Sounds pretty sensible to us, and this means the markets might still get a surprise this afternoon on what is surely an interest rate ‘non-decision’ announcement. And if there is any market misinterpretation of whatever the FOMC has to say about balance sheet reduction, one of those classical ‘adjustment’ press releases that have been issued so many times before can always be released timely.
If the Fed could do that after the misinterpretation of Alan Greenspan’s December 1996 ‘irrational exuberance’ statement, it can surely do so to clarify a much more finite plan to shrink its balance sheet. And in any event, the indication from informed sources on what can be inferred about the Fed’s reduction plan is that it will begin in very modest amounts relative to the Brobdingnagian size of the balance sheet. Yet another reason the Fed should not be too terribly concerned about announcing it in a ‘statement only’ release where the sentiment on future rate hikes is deferred until the end of this year.
Still a Surprise
All of that said, because so many market participants are convinced the FOMC will not provide any more specific information on the balance sheet shrinkage plan in a ‘statement only’ release today, it would still be somewhat of a surprise. And there could at least a temporary market backlash. The immediate impact might be into the govvies, where the Fed reversing its previous purchasing role into providing supply could upset the government bond pricing.
That would be in spite of the reasons to believe inflation remains subdued now and will likely remain lower than the Fed’s projection in future. Especially see the opinion of the estimable Gavyn Davies at the end of the opening section of last Thursday’s Commentary: ‘Normalization Bias’ NOT Back Redux post for much more on that. It is basically the breakdown of the assumptions in the old ‘Phillips curve’ analysis which the central banks have relied upon for so long.
Equities and the US Dollar
The further impact might be on the US equities that are counting on more near term accommodation from the Fed after Chair Yellen’s recent testimony. In other words, any rise in interest rates indicated by govvies weakness might also spill over into upsetting the equities in the near term. This is mostly what transpired at the end of June on the more hawkish indications from both the BoE’s Carney and especially ECB President Draghi’s speech at the Sinha ECB Forum.
And if indeed there is a sign the Fed is even incrementally tightening through the balance sheet reduction, it should be good for a US dollar that has weakened since the early part of this year. Yet, as Yra Harris points out, any sign the Fed is pursuing Quantitative Tightening (QT) while the BoJ and ECB remain on a strong QE path should be good for the greenback, yet has to be watched closely. If there is still US dollar weakness after any such indication it “…will provide a signal that investors have other concerns about the United States.”
Trump Factor (still)
And that gets back to our considerations of just how damaging are Trump’s tweets and the missteps in his actions for the potential success of his otherwise enlightened reform and stimulus agenda. While we have reviewed those at length elsewhere, those factors include the Senate decision to bring its healthcare reform bill to the floor only opening the door to what will surely be contentious debate.
That important precursor to the more important tax reform remains at risk in spite of Tuesday’s nominal success, and Trump’s Tuesday that afternoon from the Rose Garden that its passage is now almost assured. Ultimately its defeat would be a bad sign for the overall Trump reform agenda. There are also continued Trump administration issues on changes in its communications area, the Russian collusion investigation and (very important on the support from his conservative base) the status of AG Sessions.
▪ Yet for now the immediate surprise will likely be any further specifics on the Fed’s balance sheet shrinkage program being included in this afternoon’s FOMC statement.
▪ There is no Extended Trend Assessment in this post. This is a ‘macro’ assessment. In spite of the short-term impact of various matters reviewed previous, Market Observations remain the same as last weekend’s update (lower section) of last Thursday’s Commentary: ‘Normalization Bias’ NOT Back Redux post.
Thanks for your interest.
The post 2017/07/26 Commentary: Balance Sheet Backlash? appeared first on ROHR INTERNATIONAL'S BLOG ...EVOLVED CAPITAL MARKETS INSIGHTS.