Welcome to the Fed’s “day of humiliation.”
Today’s FOMC policy decision is eagerly anticipated by investors who, as Bloomberg notes, are “looking for further details about what the pivot to patience on rates means, how the new “dot plot” will look and how policy makers will approach inflation-targeting and balance-sheet runoff.” Said otherwise, what investors are really looking for is whether the Fed will be humiliated even more when, somehow, it pivots even more dovishly after its stunning dovish reversal in January, by cutting the dot plot to just 1+1 for 2019/2020 (or even 0+0 hence on hold indefinitely), while slashing its forecasts and announcing the end of the Fed’s balance sheet runoff, yet claiming that all is well and that it’s not just a case of “the Fed sees a recession that the rest don’t”, even though just three months ago the Fed was especially euphoric and the balance sheet was on autopilot.
Apparently “so much” can change so much in three months when the Fed is willing to throw away its last shred of credibility just to pump up the market.
So with that in mind, there are three key themes the market expects to see today, as per RanSquawk:
- The statement may see dovish tweaks, with a reiteration it will remain ‘patient’ and data-dependent in adjusting policy.
- The Fed’s projections for rates, growth and inflation are likely to be cut.
- The central bank is likely to signal the end of QT this year.
Here is a breakdown of the key topics that Powell may address today:
RATES: The markets are priced for an unchanged 2.25- 2.50%, and looking ahead, no further rate hikes are priced; in fact, there is roughly a 25% chance that rates will be cut this year, according to Fed Funds.
POSSIBLE STATEMENT TWEAK – labour market: Deutsche Bank argues that the FOMC will need to acknowledge the volatility in the recent data releases, as well as some signs that growth momentum is cooling, though will likely note that the underlying tone of the economy remains supportive. The recent employment situation report’s headline was weak, and this might see the Fed amend its current view that “labor market has continued to strengthen and that economic activity has been rising at a solid rate”, perhaps to “despite recent volatility job gains remain strong on average,” Deutsche suggests, while noting that the jobless rate has
POSSIBLE STATEMENT TWEAK – compensation inflation: Deutsche says the opening paragraph on compensation inflation (“although market-based measures of inflation compensation have moved lower in recent months, survey-based measures of longer-term inflation expectations are little changed”) might see the Fed mark-to-market the inflation expectations language to state that market-based measures of inflation compensation ‘have moved up but remain low’, reflecting Vice Chair Clarida’s recent acknowledgement of break evens’ tentative move higher since January. Powell also recently remarked that inflation was muted, and accordingly, the FOMC was not minded to adjust rates while inflation and growth aren’t presenting a threat.
POSSIBLE STATEMENT TWEAK – household spending/business investment: The line that “household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier last year” might be tweaked, with the word “strongly” being replaced by “moderating,” Deutsche says.
SUMMARY ECONOMIC PROJECTIONS: Goldman Sachs says the main question for the March meeting is just how far Fed officials will take the new theme of patience and the new perspective on inflation in their next set of projections.
The Fed has currently pencilled in two 2019 hikes, and one in 2020 (a configuration of 2-1-0), while the median longer-run dot is between 2.75-3.00%, which GS thinks is likely to remain in that bracket, despite the mean dot falling. The bank sees modest downward revisions to the 2019 growth view (currently 2.3%), as well as a small reduction in the longer-run growth view (currently 1.9%), and therefore believes the rate dots are likely to retain an upward tilt, despite the elimination of the iking bias from the FOMC statement, with a number of participants (but not the median participant) showing a hike in
BALANCE SHEET: The minutes from the January meeting stated that the Fed will fix the size of its balance sheet by the end of 2019, stopping QT sooner than it previously guided (in 2020). The mechanics, HSBC explains, means that the Fed will buy Treasuries from the market with the principal payments from its mortgage holdings, then rolling over all of the principal from maturing Treasuries. The growth in currency in circulation will shrink the Fed’s excess reserve position over time.
BALANCE SHEET SCENARIOS: JPMorgan notes that the balance sheet peaked at USD 4.5Tn, and is now around USD 4Tn; the bank says that the best case for the market would be that the Fed provides formal and specific balance sheet guidance at the March meeting, including a tapering in the normalisation pace (from the current USD 50bln ceiling) with an objective to leave the balance sheet at between USD 3.6-3.8trln by Q4 this year, with excess reserves at between around USD 1.3-1.4trln+. JPM’s base case, however, is that the Fed will tell us to expect normalisation to conclude with a terminal size of between USD 3.5-3.6trln by late 2019, leaving excess reserves at between USD 1.1-1.25trln. The worst-case, would be that the Fed only provided vague guidance and pushed back against expectations for the process to conclude by the end of 2019; in that scenario, that pace of normalisation would likely be left unchanged and a balance sheet size of around USD 3.5trln might be described as being more of a floor rather than a ceiling. Meanwhile, Goldman expects the Committee to announce that runoff will conclude at the end of Q3 or—based on Chair Powell’s speech last Friday—perhaps in Q4. Recent comments from Fed officials suggest that the size of the balance sheet will then likely be held constant in nominal terms for some period to further reduce reserves at a more gradual pace through the growth of non-reserve liabilities such as currency. During that period, maturing MBS will be reinvested in Treasury securities, an option noted in the January minutes. While the Fed is expected to shift its Treasury portfolio toward greater holdings of shorter-term securities eventually, Governor Brainard’s comment last week that this issue will not be addressed “for some time” suggests a decision is unlikely at the March meeting.
FED NOT DONE HIKING: Echoing Morgan Stanley, which expects 4 more rate hikes by the end of 2020, Goldman said that despite the FOMC’s elimination of the hiking bias from its statement, it does not think the hiking cycle is over or that the dots will show a flat path. With the median participant still likely to put neutral at about 2.75%, a funds rate of 2.25-2.5% seems like a premature stopping point for a business cycle in which the unemployment rate will likely again reach its lowest level in half a century. Most FOMC participants would feel more comfortable adopting a true “no lean” stance after another hike or two. And while Goldman does not expect the median dot to show another rate hike until 2020, its own forecast continues to call for a rate hike later this year, and expects a December hike as the most likely outcome under its forecast of growth modestly above trend and core inflation modestly above 2%.
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So while there’s a lot of uncertainty surrounding what the Fed will unveil, markets have been absolutely giddy as shown by the rally in stocks and collapse in cross-asset volatility with bond vol hitting new all time lows yesterday, a sentiment that has been only boosted by other central banks following in the Fed’s dovish footsteps.
The question is will the calmness continue going out of the Fed meeting tonight? To be sure, one event that would instantly end the market’s complacent slumber and send the VIX shooting higher is if Powell makes a second U-turn in 3 months, reverses from dovish to hawkish, and hints that its next move will be a hike. To be sure, the higher the S&P – now back to near all time highs – rises, as bond yields plunge, the greater the possibility of such an outcome.
Steeping away from what may happen, to what has happened, Deutsche Bank conveniently summarizes that on Powell’s first seven FOMC meetings, the S&P 500 ended up lower on the day of the policy announcement. However, this trend reversed in January when the S&P 500 rallied +1.55% on the dovish pivot.
If Fed chairs kept score, Powell would still trail his predecessors, since the S&P 500 has fallen on average -0.25% on FOMC meeting days under his leadership. The averages for Yellen (+0.17%), Bernanke (+0.55%), and Greenspan (+0.18%) all make for happier reading. Incidentally, Deutsche Bank economists expect few surprises in the statement or Powell’s rhetoric: they anticipate the median rate expectation for 2019 will fall to one hike, and will be monitoring for any signals about balance sheet policy or what conditions are needed to allow for another hike.
Yet while few outright surprises are expected – unless Powell wants to throw in the towel – Wall Street analysts, desperate for some commissions, are already out with their favorite trade recos for today’s kneejerk response. Courtesy of Bloomberg, here is what some of the more prominent desks expect:
- UBS, Stuart Kaiser et al.
The euro has larger average and absolute moves — 0.9 percent and +/- 1.2 percent, respectively — than assets like the S&P 500 or 10-year Treasury yields when dots are lowered, strategists led by Kaiser wrote in a note Monday. The yen has also responded to lower dots, but to a lesser extent: “FX moves suggest a global risk-on dynamic, so low FX implied volatility offers attractive optionality for the FOMC,” UBS said.
Don’t expect a major move in stocks: most of the impact on stocks from the Fed meeting will come before the announcement, UBS said. The S&P 500 has moved +/- 0.6 percent on days of Federal Open Market Committee statements since 2012. However, on the five occasions dots were lowered, the gauge rallied an average 1.8 percent in the week before the meeting, “suggesting the moves were well-telegraphed.” And yet, S&P 500 returns were negative on average in the following week, UBS said.
- Goldman Sachs, Zach Pandl, Ian Wright
Goldman is looking for confirmation that the FOMC’s move away from trying to tighten financial conditions will last for some time, which is one of the key points in the company’s medium-term bearish U.S. dollar view, strategists led by Pandl wrote March 15. “Focus on a potential shift by the Fed to an average inflation target remains, and is likely contributing to U.S. break-even inflation and real rates moving in opposite directions recently,” strategists led by Wright wrote March 18.
During four periods since 1980 when the Fed held rates relatively high for an extended time, “at face value we find equities tended to do relatively well, although toward the end or the beginning of each period performance appears more mixed,” Wright said, adding that the tech bubble influences some of the observations.
- Natixis, Joseph Lavorgna
Investors may be overly optimistic about the Fed’s ability to deliver fully on both the interest-rate and balance-sheet fronts, Lavorgna wrote in a note Tuesday, noting that the futures market now expects the next move on rates to be a decline. “The size of the Fed’s portfolio is currently $3.79 trillion, down from a peak of $4.25 trillion in February 2017. The consensus assumes it will stop shrinking at $3.50 trillion,” Lavorgna wrote. “If the Fed does not confirm these expectations, a renewed bout of market turbulence could begin. Stay tuned.”
- BMO Capital Markets, Jon Hill, Ian Lyngen
The Fed decision has a strong possibility of being a “buy the news, sell the fact” event given extremely dovish expectations, Hill and Lyngen wrote in a March 18 note. They’re watching the 2s/10s curve, “particularly if the set-up for Wednesday corresponded to price movements probing multi-week lows,” they said. “This would indicate that momentum going into the decision is clearly leaning toward a flattening bias, at least in this benchmark curve, and open the door for a quick steepening back toward 20 basis points were the median 2019 dot to imply zero additional hikes.”
“The Fed’s aim is certain to be a continuing of the peaceful low-vol regime,” the strategists wrote. “Although the FOMC represents a potential risk event,” they said, “any resulting vol spike would likely be interpreted as a Powell-produced policy error.”
- BNY Mellon, John Velis
Currencies are unlikely to react heavily to the FOMC statement, according to Velis: “With central banks around the world seemingly simultaneously warning of downside risks and setting policy to the dovish side of the spectrum, it would require the Fed to come out and practically assure us that rate cuts will be seen in the future (or conversely, suddenly rediscover their previous tightening bias) to upset the stability (some might say dead calm) currently observed in the currency markets,” Velis wrote in a note Tuesday. “We view this as a low-probability risk.”
- Evercore ISI, Krishna Guha
While the Fed’s plan to conclude its balance-sheet reduction is likely to come in the second half of the year, “when the reinvestment plan comes, it will skew towards bills and other shorter-dated Treasuries, favoring a slightly steeper yield curve,” according to Guha. Any comments from Powell in the press conference on reinvestment should be consistent with that, he said.
- Mizuho Bank, Vishnu Varathan
“A pure short on the long end may be also on the cards, if one believes that ‘patient’ has been too stretched as of now, and so long-end yields may have to go a little higher (or at least adjust off the lows),” Varathan, the head of economics and strategy, said.