We received some interesting feedback on our FOMC choices. Sources tell us the “higher ups” on the Committee are skeptical of actions less than 25bps. The panel doesn’t believe smaller moves can/will make proper condition changes in the economy.
This begs the question : Then why raise rates at all? We were laying out a possible path to normalization. If the concern of the FOMC is slowing credit and thus economic activity, then raising rates is a moot point. We believe our method would increase confidence and facilitate credit by signaling the end of ZIRP on a “principles” basis. The source information also means the first move will be even more attenuated.
The FOMC could instruct the OM Desk to move the Effective FF rate toward .25 in the days leading into the March meeting and then explain the activity at the presser. This is a gentler start as IOER would not need to be raised.
David Lettermen has a running bit where he drops various objects into a pool of water and asks “Will it float?” After yesterday’s chat with Michael Sedacca and Vince Foster for Minyanville, I decided to run an experimental matrix of what FOMC movements may attempt next year. Spoiler Alert: It doesn’t look like it floats.
The problem comes from the flood of international cash and low demand for dollar borrowings in the unsecuritized/uncollateralized interbank market. Despite myriad regulatory changes the “old rule” (more like a guideline) that 3 month LIBOR is/should be 14bps over FF continues to calibrate in times of stability. However, as rates are moved upward – in my example with 2 small moves before a 25bp move – Interbank will price in multiple moves (denoted by ++ on chart)…PROVIDED DEMAND INCREASES as we move off ZIRP (a theory we have but could be wrong)
Also, it is reasonable to suspect that Fed attempts to create a soft floor would not be any better with a hard FF target (as before) rather than a range that I suggest here. The range essentially gives cover for the probable consistent downward pressure on FF from “other” sources.
Two possible unwanted outcomes are steady pressure that suppresses interbank rates lower and longer than desired OR a significant jump up in money rate term structures more accurately reflecting the new regulatory environment and the hash reality of the end of “free money.”
GC could continue to trade as if in shortage -like now – in either scenario and there is little support for the notion that heavy Death Star participation will change this.
No CB has successfully exited itself from QE. We are going to give it a go…cue Paul and the band for a drum role….Will it float???
Kevin Ferry and Vince Foster discuss Bonds, Interest Rates & Fixed Income Investing.