2023

Good morning, everyone. Plenty of Fed speak to digest since the FOMC decision last week highlighted with Chair Powell yesterday. The US rate market indicated we learned little new. The BOE surprised with a 50-basis point hike. But when looking at the recent charts with UK inflation perhaps not surprising. Chair Powell in front of the Senate at 10am. And Atlanta Fed President indicates the bar for more hikes is high and the pause is in. For markets, this is a story of liquidity drain moving forward, and we've written. The liability side of the Fed's balance sheet. Additionally, we have the evolution of the regional bank issues, the credit story, and regulatory changes. We believe the yield curve is reflecting some of these concerns. The speed of central bank policy is diverging. BUT, for the most part, and as seen by the Bank of Canada, RBA, and Chair Powell's comments yesterday: the fight against inflation remains front and center. Fed "hold rates steady", BOE full speed ahead.?

Let's Take a Look

Well, one thing is perfectly clear; there is no longer a need for speed. In explaining the Fed's decision to "hold rates steady" at last week's meeting Powell has been clear: it's about the terminal level not the rate in which we get there. And YES, we are using a new phrase, "hold rates steady". The Chairman was very feisty when the Fed's move was referred to as a "pause". "We didn't use that word last week and I wouldn't use it today"! Chair Powell, did you order the pause?, LOL! Jay Powell is very sensitive to his committee members this is for sure. And likely no easy task to avoid dissention. But in his words the fight back to 2% has a way to go.?

There were interesting moments. Like when the Chair was asked (in overtime for the testimony clock) whether he knew or not if any names on the Fed's Master Account List were non-FDIC insured entities. Blank look: "I don't know". Hmmmm. Most of the testimony and Q/A was largely expected. The House is comprised of local districts. The concerns are mainly local and how Fed policy trickles down to the district level. To that end, questions around capital, regional, and community banks makes sense. To Powell's end an emphasis on fairness with small bank regulation and capital requirements. But an acknowledgement, that despite being the Fed Chair that might not be the outcome. It further highlights the nature of the organization. Similar to what was seen with the SVB failure: 50-basis points one week higher in the FF rate (Fed Chair) to a 3.50% 2-year yield.

On the balance sheet Chair Powell offered little on specifics (ultimate size) because he doesn't know. Plenty of comparison to 2019 but we would disagree. The Fed has implemented new tools to deal with potential disruptions. And reserves in the system are still plentiful but down by a trillion since the peak in late 2021. How the replenishment of the Treasury General Account throughout 2023 flows through to RRP versus bank reserves will dictate the evolution of balance sheet runoff. But Powell was clear: reserves need to be abundant PLUS a cushion. So, the end of QT (runoff) may be closer than we think.?

So, the debate between maximum employment remained a theme. Not a big surprise. For the most part right now, a debate doesn't exist when one is so far from target. And for the three reasons Powell repeated yesterday of the components in place for lower inflation (below trend growth, supply chain alleviation, and supply demand imbalances for labor), it's clearly #3 which is critical. And the one linked most closely to inflation, services ex-housing and 54.5% of Core PCE which is of most concern. And would add, the big buck the Fed is looking to get from housing is questionable too as Redfin reports yesterday home availability for May hit an all-time low. And supports our recent anecdotal evidence and conversations. People are stuck in their homes because of the rate structure created during the pandemic, supply is still an issue, and rentals are tight.??

In the end, we sit with an extremely inverted yield curve. The spot UST 2/10 Treasury curve moving back toward cycle lows. The regional bank issues in March had us at these levels not too long ago. And the chart below, 10-year US inflation breakeven rates versus Core PCE inflation. It highlights the Fed's work to date (constructive with inflation expectations) and market's belief that despite elevated short-term inflation that the Fed will ultimately succeed. Believe two more rate hikes or not, the Fed speaking as firmly as they have despite "holding rates steady" and the two additional moves in the SEP is part of maintaining control. It also means practically, if the data doesn't cooperate, the market will force them to move higher.??

Have a great weekend!