FAST FIVE: Nomura Exposes The Fed's Imminent "Mega-Shift" – Beware Quad Witch & "Untethered" Markets
Another massively over-subscribed repo liquidity injection this morning, coupled with The Fed's dramatic loss of control of rates suggest what McElligott calls a “potential mega-shift” in policy from The Fed.
Source: Bloomberg Nomura Chief Economist Lew Alexander shifted his call for today's FOMC meeting to include: An announcement that the Fed will resume the expansion of the balance sheet again in coming weeks (in addition to a 25bps cut and likely announcement of ongoing “as needed” repo transactions in order to maintain short-term interest rates within a range that is consistent with the target range for funds rate-however, we still do NOT anticipate an imminent announcement of a “Standing Repo Facility” nor another lowering of IOER relative to the top of the FF target range today-while we also expect the dots to show no further rate cuts at this juncture, despite our “house” call for one more cut in either Oct or Dec) McElligott's Bottom line: Due to the acute nature of the $funding stress dynamic in recent days, I believe the delta of a Fed “balance sheet expansion” headline today (one which would begin imminently) is significantly underpriced in the market and risks catching investors “off guard”.
The market's “muscle memory” in the post-GFC period has condition many participants into believing that “balance sheet expansion = QE” and risks a “BULLISH risk-asset sentiment shock” (FWIW, “BS expansion = QE” is NOT actually the case per se, as what we think the Fed plans to do is much more “QE-Lite” in order to offset the Reserve depletion dynamic-NOT inject incremental liquidity “above and beyond” to actually “pump up” Reserves).
“liquidity IN, risk ON” (“Spooz and Blues” of the original QE era) A move to expand the balance sheet (or even resume QE outright) has always, of course, been considered a “down-the-road” / “break glass in case of emergency” option in the event of recession risk escalation-but has not been part of the “NOW” vernacular But due to the urgent $funding dynamic as per dysfunctional money market behavior in recent days, we believe that the time-line has been accelerated FWIW, this “balance sheet expansion” can be enacted quickly, in the sense that we simply expect the Fed to effectively “upsize” the already-resumed asset purchases being conducted (restarted last month in order to offset the runoff of the existing UST and MBS securities in the Fed portfolio) The thing is, this action (as we expect it) are far more “QE-Lite” than probably what the majority of investors may misinterpret as a resumption of outright “QE” – many market participants do not realize that the balance-sheet expansion was a natural dynamic PRE-crisis, as it rises alongside the amount of currency in-use Most importantly and as of “right now,” the goal is to stop the shrinkage / offset the draining of Reserves-and NOT necessarily introduce (“pump”) NEW incremental Reserves above and beyond the “offset” level Nonetheless, from a “stock versus flow” perspective, this matters MASSIVELY in my eyes, as it is about a TRAJECTORY or “impulse” change of the BS (“flow”) and not the absolute size of the BS (“stock”)-thus is likely to be interpreted “bullishly” for Risk assets Market permutations-not linear: The TRILLION DOLLAR QUESTION today is this: if our expectations for the Fed are correct today, how does the market respond to a potentially MIXED-MESSAGE where 1) balance sheet is set to be imminently expanded again via larger POMOs (and liquidity is being injected to offset this acute Reserve depletion) YET against a backdrop where 2) the market's very dovish expectations for a deeper Fed easing-path may now be reassessed / re-priced “lower”.
Secular Growth and Defensives over Cyclical Value) Markets hear “imminent BS Expansion” and think “outright QE” muscle-memory-regardless of Fed rate path disappointment risk, which is subject to economic data trajectory from here anyhow * * * Finally, McElligott points out that the timing of this potential Fed policy inflection development is particularly significant in the sense that Equities are likely about to become “untethered” by massive “Long Gamma” impact on markets in recent days, which have kept markets incredibly “sticky” despite a number of “shock” market moves ($Funding, Crude, Equities Momentum) and “shock” geopolitical developments (no big deal, just an Iran proxy-war strike into the heart of Saudi on a direct attack of 5% of the world's Crude output) in recent days.