Mopping up liquidity

Next December 14th the FOMC economic projections and the ensuing press conference by Powell will provide some guidance on the near term direction of monetary policy. Markets are already positioned for a 50bp hike, so they are focused on indications about the terminal rate and when the Fed will pause its tightening moves. These elements will drive not only the stock and bond markets' performance until year’s end but also expectations on the likelihood of a recession and its depth. And it is the press conference together with the “dot plots” that will set the stage for that.

The European Central Bank is relieved that inflation seems to have peaked in the eurozone, This relief increases the likelihood that the ECB will hike by only 50 bp at its Dec. 15 meeting. However, at a recent conference, Lagarde expressed skepticism that inflation has peaked and warned about the danger of letting expectations become unhinged. This implies that the Governing Council may err on the side of greater hawkishness in an effort to strengthen the ECB’s credibility.

Looking ahead, it is still unclear how the central banks will mop up the flood of liquidity they created for the past 15 years. So far the interest rate hikes have only marginally dented the size of the central banks' hypertrophic balance sheets. Powell and Lagarde remain a few trillion dollar away from normalcy and away from lunacy.