My most sincere and humble apologies to the members of the FOMC.
I had pre-emptively accused them of being boring. The minutes of the March 15 FOMC said “policymakers discussed the likely level of the federal funds rate when a change in the committee’s reinvestment policy would be appropriate. Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the committee’s reinvestment policy would likely be appropriate later this year. Many participants emphasised that reducing the size of the balance sheet should be conducted in a passive and predictable manner.” That finally blew the smoke away from the playing field.
Tapering is one thing, reducing the Fed’s balance sheet is something entirely different. Markets had neither anticipated nor priced in a reduction of the balance sheet as early as the back end of this year and the response was one of, pardon the term, shock and awe.
POWER RANGERS
Although the Dow only closed down by 41 points, or 0.2%, the full story is a bit more revealing as the index had been trading happily higher by about 150 points over the Tuesday close, only to shed around 200 points into the close while the US yield curve rallied, albeit only marginally. Nothing looks quite as shaky as it did at the time of the “taper tantrum” – whoever came up with that one should be summarily shot – but I suspect more because the bond markets can’t yet work out how to price a potential change in policy than due to deeply thought through valuations.
The up-front facts are simple enough. In order to stop the economy from falling off a cliff when excessively available and ridiculously cheap private sector credit dried up in 2007/2008, the state stepped in as the borrower of last resort. QE was a central bank-provided buying programme for all the newly created debt in order to avoid investors being flooded and the cost of borrowing going through the roof due to the economics 1.0.1-style excess demand for credit over its supply. The thing about credit is that it’s so much easier to create than it is to remove. This was the experience of the West in 2008 when it became clear that the only way to avoid an implosion of the economy in the wake of the credit crisis was by creating more credit.
“Policymakers also discussed the potential benefits and costs of approaches that would either phase out or cease all at once reinvestments of principal from these securities,” the FOMC continued. “An approach that phased out reinvestments was seen as reducing the risks of triggering financial market volatility or of potentially sending misleading signals about the committee’s policy intentions while only modestly slowing reductions in the committee’s securities holdings. An approach that ended reinvestments all at once, however, was generally viewed as easier to communicate while allowing for somewhat swifter normalisation of the size of the balance sheet.”
It might have been trying to soften the impact of its bombshell but it all ends up a little like asking the patient whether he prefers to have his leg amputated before or after the arm is amputated too.
TRANSFORMERS
At the beginning of the crisis in summer 2008 the Fed’s balance sheet footings stood at around US$890bn. That figure is now closer to US$4.5trn. At the same time, in summer 2008, the total national debt was just below US$10trn. That is now, as we all know, much closer to US$20trn. So US$3.6trn of the US$10trn or roughly one third has been absorbed by the Fed. Thus the market, including foreign central banks, holds US$16.3trn. Over time, as the Fed deleverages, the market will not only have to absorb the bonds the Fed will no longer be buying – the minutes speak of passive deleveraging - but it will also be asked to fund the ongoing deficit and then the US$2trn that President Trump wants to spend on infrastructure. Now take your abacus and go figure where to price the US yield curve while also accounting for increasing debt service costs on an economy with over 100% debt/GDP on a federal level but with 361% total indebtedness/GDP.
The minutes do include a caveat that suggests that “a number of participants indicated that the committee should resume asset purchases only if substantially adverse economic circumstances warranted greater monetary policy accommodation than could be provided by lowering the federal funds rate to the effective lower bound”. The market took this to mean that rates must fall before QE could be reintroduced. I hear what they say but I also know that they can change their mind any time they choose to. I do not believe that, having enjoyed the power to manipulate any part of the yield curve at will, the Fed will easily give it up. And, to be sure, the ECB has no intention of doing that at all. In fact, the probability of us experiencing an entirely market-priced yield curve in our working life looks very slim indeed.
MASTERS OF THE UNIVERSE
So while the masters of the world of golf assemble in Augusta, Georgia, the masters of the world’s two leading economies will be meeting in Mar-a-Lago, Florida. Presidents Xi and Trump might not be planning to play golf together - Xi hates the bloody game - but the meeting will be all about long drives avoiding the bunkers, cautious approach shots and an accurate short game. Trump gives the impression of wanting to win and thinking he can do so with nothing more than a bunch of one wood drivers in his bag.
The US president has a habit of shooting from the hip, which might have looked good on the stump but will get him nowhere with the leader of a country with four times the population of the US and the economic potential to keep on growing until it has left America in its wake. Not this year, not next year but sooner or later it will and there is nothing the Donald can do to stop that. Xi knows that, we know that, but I’m not sure whether Trump and his cabal do and if they do, whether they want to believe it or dismiss it as fake news made up by the New York Times.
Speculation is rife as to what will be discussed, in what order and with what outcome although I believe it to be fatuous to try to second guess this one. What I do know, though, is that it has been over 10 years since the world’s number one ranked golfer has won the Masters and the odds are probably not on Mr America First carrying off the grand prizes from Mar-a-Lago either. Trump might be a businessman but businessmen do business with other businessmen, not with consummate politicians of the ilk of Xi Jinping. Xi surely did not rise to his position by being frank and open.
Tomorrow brings the second round of the Masters and the US employment numbers for March. If yesterday’s ADP national employment report is anything to go by – it knocked the cover off the ball at 263k as opposed to the forecast of 185k – then the 170k nonfarm payroll consensus forecast could also prove to be woefully too low.
With all of this going on and with the New York trading floors watching live TV from Augusta, today does not look like an auspicious day to be taking any major trading decisions. Too many moving parts to be dealing with at once but if I were to be asked how to position, which of course I’m not, I’d probably and for choice go out of Thursday and into Friday a small short.