iFOREX | Mar 21, 2019 06:52AM ET
USDJPY closed around 110.67 in the US session Wednesday, stumbled by almost -0.65%, on a dovish hold by Fed as it projected no further rate hikes in 2019 and will also taper/halt the QT (B/S reduction) partially by Sep’19. The market was expecting at least one dot (rate hike probability) by the Fed in 2019 and end of QT by H2CY2020. In the longer run, the Fed will maintain a B/S size at around $3.76T, against an earlier expectation of $3.5T.
Subsequently, soon after Fed/Powell, the USD tumbled to a session low of 110.54 and Dow jumped over +200 points (from its session low) to a session high of 25906.30. Earlier Dow tumbled over -200 points and made a session low of 25670.63 after Trump said his administration was discussing leaving tariffs in place on Chinese goods for a “substantial period of time”, although he is expecting a “great China trade deal” in the coming days.
On Wednesday, as highly expected, the Fed kept the US rate unchanged at +2.40% (2.25-2.50%) unanimously and also the IOER (Interest Rate on Excess Reserves) unchanged at 2.40%. The Fed intends to slow/taper balance sheet runoff starting in May and ending in September (partially-only Treasuries), provided economy evolves as expected.
At present, the Fed is allowing a maximum of $30B of Treasury securities to roll off its balance sheet every month. Starting in May, the maximum amount of Treasury securities that will be allowed to roll off will be reduced to $15B per month and further starting in October the overall size of the balance sheet will remain unchanged, for an unspecified period of time. The Fed is currently tapering its $4.5T B/S by $50B/per month ($30B treasuries and $20B MBS) in an auto-pilot mode.
The Fed's Balance Sheet:
The Fed announced that they would close the Treasury securities portfolio unwinds at end Sept '19. The Fed will taper the Treasury unwind by reducing the cap on monthly redemptions from the current level of $30B to $15B beginning in May '19. But the Fed will reinvest maturing MBS across the UST curve, not towards the front end as the market expected. The Fed will cap MBS redemptions at $20B/month and any prepayments above this amount would be reinvested into MBS. The Fed will also hold their aggregate securities holdings constant for a time and allow for a continued shrinking of reserves via non-reserve liability growth (i.e. currency in circulation).
In October, the Fed will purchase enough Treasuries to offset the reduction in MBS holdings. The aggregate portfolio will be unchanged starting in October. Thus the US bond yield will be under stress and it’s like the YCC (yield curve control) by the BOJ.
As a result of the early end to the runoff, the Fed's total B/S size may end the normalization/QT at $3.76T with $1.22T in reserves. As a reference, the Fed’s B/S peaked at $4.5T, rising from well under $1 trillion prior to the great financial crisis in 2008 (GFC).
While overall, the B/S announcements were consistent with what the market consensus had anticipated, the biggest surprise was the decision to reinvest US Treasuries across the curve as opposed to concentrating these reinvestments at the front end, meaning that there are no plans to launch a reverse Operation Twist at this time (less dovish than expected).
Moreover, such a plan would only gradually reduce the average maturity of the Fed's Treasury holdings. The average maturity of the Treasury debt outstanding is about 70 months (5.8 years).
Looking ahead, while the overall Fed portfolio will be flat after September, the Fed should be buying roughly $45B per quarter to offset the liquidation of MBS. Annualized, the Fed should be a net buyer of about $180B per year of Treasury securities. If the Treasury is financing $1.0T deficits annually, purchases by the Fed become a meaningful source of funding, which may enhance its ability to offer fiscal stimulus in a scenario of an economic slowdown.
Some reports also suggest that in the coming days, the Fed will likely need to grow its portfolio (B/S) again. The Fed admitted this in its update of, "Balance sheet normalization principles and plans” that it can start increasing the balance sheet in H2CY20. The growth should be accomplished with even more Treasury purchases.
On Wednesday, the Fed Chair Powell cited some reasons behind Fed’s “patience”: Chinese and European slowdown, the US stock market plunge in Q4, mixed US economic data at the start of the year, and the “fact” that the Fed has not met the 2% inflation (headline CPI ?) mandate.
With the headline CPI (inflation) running below Fed’s target (?) of 2%, the Fed believes it is not meeting the mandate in a "symmetric” way. Thus the policy prescription is therefore for the Fed to hold policy rate at present levels and be "patient" to allow the inflation to move up. This also means that the only gating factor for a reversal to a more hawkish Fed will be a jump in inflation, which may occur in late 2019 or early 2020. Thus the Fed has kept 1-dot for 2020 (theoretical rate hike projection). At present, the Fed thinks that it’s ahead of the inflation (headline CPI) curve as it changes the “inflation” definition narrative from earlier core PCE to headline CPI.
On financial stability risks, i.e., an asset bubble, Powell once again downplayed concerns arguing that the Fed does not see vulnerabilities as elevated. The Fed is monitoring certain aspects of financial markets but not allowing it to alter their policy for interest rates. Powell said the key tools for managing financial stability are "regulatory" rather than “rates”.
The FOMC committee also downgraded its assessment of the economy, saying that “growth of economic activity has slowed from its solid rate in the fourth quarter”. More formally, the median FOMC member now forecasts that real GDP will grow 2.1% in 2019, which is down from the 2.3% rate that the median projected in December.
Overall, the Fed is quite dovish about the US economic (GDP) growth prospect, household spending, and private/business capex, while neutral about US core inflation (although dovish about headline CPI) and employment (upbeat wage growth but downgraded its unemployment forecast).
Thus Fed is refrained from further rate hikes and stopped its “runaway loco” at +2.50% after the last rate hike in Dec’2018 (total 9-rate hikes from Dec’2015 in its rate hiking cycle of 3-years from +0.25%).
Now, at +2.50%, the will be in “neutral” mode unless the US core PCE inflation shoots above +2.25% or plunge below +1.75%. Although, the Fed always go by the US core PCE inflation “goal post” in its inflation targeting (at least for the last few quarters), this time, in March the Fed talked about the subdued headline CPI at +1.5% in support of its “neutral” stance. At that sense, at +2.50% of Fed rate and +1.50% of headline CPI, the real rate of interest (RRI/neutral rate) is now around +1.00%, at Fed’s target.
The Fed is now clearly assuming lower energy/oil prices in its inflation projection (headline CPI). The US headline CPI is now around +1.5% in first 2-months of 2019 against last year’s +2.5% on an average, thanks to a plunge in oil and its favorable base effect.
The US core CPI is now around +2.1%, almost at the same levels of +2.2% on an average in 2018. The US core PCE inflation is now around +1.9%, almost at the same average level of 2018. Thus Fed may find itself behind the inflation curve if crude oil suddenly jumped again and sustain around $65-75 from present levels of $50-60. There is also some threat of tariff inflation on the US economy as Trump will not withdraw his 10% additional China/others’ tariffs.
Remarkably, in just six months, the Fed has gone from an outlook with rates in the restrictive territory to rates still somewhat accommodative by the end of 2021. Powell & co clearly blinks amid intensifying pressure from their political boos Trump.
The Fed said: “The US economic growth has slowed from the solid rate in Q4, but the labor market remains strong and on average, job gains have been solid. Various economic indicators point to slowing growth in household consumption and business investment. The inflation has declined largely due to energy, while the market-based measures of inflation expectations (PCE) remained low and survey-based inflation (core CPI) little changed.
The FOMC full statement for March 2019:
“Information received since the Federal Open Market Committee met in January indicates that the labor market remains strong but that growth of economic activity has slowed from its solid rate in the fourth quarter. Payroll employment was little changed in February, but job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Recent indicators point to slower growth of household spending and business fixed investment in the first quarter”.
“On a 12-month basis, overall inflation has declined, largely as a result of lower energy prices; inflation for items other than food and energy remains near 2 percent. On balance, market-based measures of inflation compensation have remained low in recent months, and survey-based measures of longer-term inflation expectations are little changed”.
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes. In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes”.
“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments”.
Fed’s Balance Sheet Normalization Principles and Plans:
“In light of its discussions at previous meetings and the progress in normalizing the size of the Federal Reserve's securities holdings and the level of reserves in the banking system, all participants agreed that it is appropriate at this time for the Committee to provide additional information regarding its plans for the size of its securities holdings and the transition to the longer-run operating regime”.
“At its January meeting, the Committee stated that it intends to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates and in which active management of the supply of reserves is not required. The Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization released in January as well as the principles and plans listed below together revise and replace the Committee's earlier Policy Normalization Principles and Plans”.
“To ensure a smooth transition to the longer-run level of reserves consistent with efficient and effective policy implementation, the Committee intends to slow the pace of the decline in reserves over coming quarters provided that the economy and money market conditions evolve about as expected”.
“The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019”.
“The Committee intends to conclude the reduction of its aggregate securities holdings in the System Open Market Account (SOMA) at the end of September 2019”.
“The Committee intends to continue to allow its holdings of agency debt and agency mortgage-backed securities (MBS) to decline, consistent with the aim of holding primarily Treasury securities in the longer run”.
“Beginning in October 2019, principal payments received from agency debt and agency MBS will be reinvested in Treasury securities subject to a maximum amount of $20 billion per month; any principal payments in excess of that maximum will continue to be reinvested in agency MBS”.
“Principal payments from agency debt and agency MBS below the $20 billion maximum will initially be invested in Treasury securities across a range of maturities to roughly match the maturity composition of Treasury securities outstanding; the Committee will revisit this reinvestment plan in connection with its deliberations regarding the longer-run composition of the SOMA portfolio
“It continues to be the Committee's view that limited sales of agency MBS might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public well in advance”.
“The average level of reserves after the FOMC has concluded the reduction of its aggregate securities holdings at the end of September will likely still be somewhat above the level of reserves necessary to efficiently and effectively implement monetary policy”.
“In that case, the Committee currently anticipates that it will likely hold the size of the SOMA portfolio roughly constant for a time. During such a period, persistent gradual increases in currency and other non-reserve liabilities would be accompanied by corresponding gradual declines in reserve balances to a level consistent with efficient and effective implementation of monetary policy”.
“When the Committee judges that reserve balances have declined to this level, the SOMA portfolio will hold no more securities than necessary for efficient and effective policy implementation. Once that point is reached, the Committee will begin increasing its securities holdings to keep pace with trend growth of the Federal Reserve's non-reserve liabilities and maintain an appropriate level of reserves in the system”.
Fed’s latest median economic projections: 2019
GDP: +2.1% vs +2.3% prior
Unemployment rate: 3.7% vs 3.5% prior
PCE Inflation: +1.8% vs 1.9% prior
Core PCE Inflation: +2.0% vs 2.0% prior
Fed Fund Rate: +2.4% vs +2.9% prior (note- current Fed rate: 2.25-2.50%; i.e. 2.38%~2.40%)
Thus the Fed lowered its GDP growth projection for 2019 from an earlier (Dec’18) estimate of +2.3% to +2.1% and also projected higher unemployment rate at 3.7% from earlier estimate of 3.5%. But the Fed kept its core PCE inflation unchanged at +2.0% symmetrical levels, while projected no further rate hikes in 2019 against Dec projection of 2 more hikes.
Powell’s Press Conference Opening Remarks (Prepared Texts):
“Good afternoon everyone, and welcome; I will begin with an overview of economic conditions and an explanation of the decisions the Committee made at today’s meeting”.
“My colleagues and I have one overarching goal: to sustain the economic expansion, with a strong job market and stable prices, for the benefit of the American people. The U.S. economy is in a good place, and we will continue to use our monetary policy tools to help keep it there. The jobs market is strong, showing healthier wage gains and prompting many people to join or remain in the workforce. The unemployment rate is near historic lows, and inflation remains near our 2 percent goal. We continue to expect that the American economy will grow at a solid pace in 2019, although likely slower than the very strong pace of 2018. We believe that our current policy stance is appropriate”.
“Since last year, however, we have noted some developments at home and around the world that bears close attention. Given the overall favorable conditions in our economy, my colleagues and I will be patient in assessing what, if any, changes in the stance of policy may be needed. Let me explain in more detail how incoming data warrant our current stance and a wait-and-see approach to changes”.
“With the benefit of fiscal stimulus and other tailwinds, growth in 2018 was strong—in fact, at 3.1 percent, the strongest year in more than a decade. For some time, most forecasts have called for growth to continue in 2019 at a somewhat lower but still healthy pace. For example, last September, Committee participants saw growth coming in at about 2.5 percent this year”.
“Data arriving since September suggest that growth is slowing somewhat more than expected. Financial conditions tightened considerably over the fourth quarter. While conditions have eased since then, they remain less supportive of growth than during most of 2018. Growth has slowed in some foreign economies, notably in Europe and China. While the U.S. economy showed little evidence of slowdown through the end of 2018, the limited data we have so far this year has been somewhat more mixed”.
“Unusually strong payroll job growth in January was followed by little growth at all in February. Smoothing through these variations, average monthly job growth appears to have stepped down from last year’s strong pace, but job gains remain well above the pace necessary to provide jobs for new labor force entrants. Many other labor market indicators continue to show strength”.
“Weak retail sales data for December bounced back considerably in January, but on balance seem to point to somewhat slower growth in consumer spending. Business fixed investment also appears to be growing at a slower pace than last year. Inflation has been muted, and some indicators of longer-term inflation expectations remain at the low end of their ranges in recent years. Along with these developments, unresolved policy issues such as Brexit and the ongoing trade negotiations pose some risks to the outlook”.
“Much of the discussion at our meeting focused on what we should make of the varied indicators. Today’s Summary of Economic Projections, the SEP, reflects the assessments of individual Committee participants. And these views are in line with a broad range of other forecasts, and point to a modest slowdown, with overall conditions remaining favorable”.
“FOMC participants now see 2019 growth at roughly 2 percent, with the unemployment rate remaining below 4 percent. Core inflation, which omits the effects of volatile food and energy prices, is remaining close to 2 percent. Declines in oil prices since last fall are expected to push headline inflation below 2 percent for a time, but this effect is likely to be temporary”.
“Now I am describing views of the most likely outcomes, but historical experience reminds us that growth and inflation this year could be stronger or weaker than what we now project”.
“The federal funds rate is now in the broad range of estimates of neutral--the rate that tends neither to stimulate nor to restrain the economy. As I noted, my colleagues and I think that this setting is well-suited to the current outlook, and believe that we should be patient in assessing the need for any change in the stance of policy. Patient means that we see no need to rush to judgment. It may be some time before the outlook for jobs and inflation calls clearly for a change in policy”.
“In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case”.
“Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates”.
“Today, the Committee released revised Balance Sheet Normalization Principles and Plans. We have long said that the size of the balance sheet will be considered normalized when the balance sheet is once again at the smallest level consistent with conducting monetary policy efficiently and effectively. We have sought to make the normalization process transparent, predictable, and gradual in order to minimize disruption and risks to our dual mandate objectives”.
“Today’s announcement is the result of discussions over the past four FOMC meetings about how best to achieve these goals. The plans have many technical details, and I’ll be happy to answer questions on those details, but for now, I’ll summarize the key elements”.
“Since October 2017, we have been allowing our asset holdings to decline by not reinvesting all of the payments we receive as securities matured or were prepaid. Today, we announced that we intend to slow the runoff of our assets starting in May, and to cease runoff entirely in September of this year”.
“In September, reserve balances may still be somewhat above the level required to conduct policy efficiently and effectively. If this is so, we may hold the size of our asset holdings roughly constant for a time”.
“During this time, ongoing gradual increases in currency and our other non-reserve liabilities would imply very gradual declines in reserve balances. When the Committee judges that reserves should not decline further, securities holdings will again begin to rise, as dictated by the growth of demand for our reserve and non-reserve liabilities. We believe that these plans will facilitate a predictable, transparent, and smooth process, and we will make additional adjustments if conditions warrant”.
“The Committee will soon turn to a few remaining normalization topics, including the desired maturity composition of our portfolio of Treasury securities. We maintain our long-stated intention to return to a portfolio consisting mainly of Treasury securities”.
Thank you. And I will be glad to take your questions.
Highlights of Powell pressure and Q&A:
“The US economy is in a good place, the goal is to sustain expansion and we continue to expect the economy will grow at a solid place. We've noted developments at home and around the world require the Fed's attention as growth has slowed in Europe, China, and other foreign economies. The limited data so far this year has been somewhat mixed and average monthly jobs growth appears to have stepped down from last year. On balance, retail sales data shows slower pace, business fixed investment too and much of today's meeting was about what to make of various indicators. It may be some time before the economy calls for a change in policy”.
“Balance sheet changes aren't related to monetary policy, but financial conditions are more accommodative than a few months ago, although the underlying economic fundamentals are slow. The Chinese and European economies have slowed substantially... clearly, we will feel that. The Chinese authorities have taken many steps to stimulate the economy and we think it will stabilize. The US tariffs are small relative to the size of the economy, but tariffs have been a prominent concern among business contacts for some time. Dots are not currently indicating a move in one direction or another”.
“We see a favorable outlook for this year and it's a great time for Fed to be patient, watch and wait. The US household fundamentals look solid, but we are not dismissing weak retail sales data. Overall we don't see financial vulnerabilities as high. The trend in inflation may reflect slack or expectations, while the run-up in wages isn't troubling on inflation. The decision on the Fed's balance sheet composition lies ahead of us and we don't see any data to push us in either direction”.
Powell added: "The data are not currently sending a signal that we should move in one direction or another and it's a great time for us to be patient. The US economy is in a good place, but Europe and China are slowing down. The Fed funds rate is now in broad estimates of neutral. Our outlook is a positive one and we don't see a recession in Europe. Overall, the data are not currently sending a signal that we should move in one direction or another and thus it's a great time for the Fed to be patient, watch and wait”.
Powell said: “Retail sales in December were inconsistent with other data. Main tools for managing financial stability are regulations. Fed’s balance sheet looks like it will be a bit above $3.5T and we are not trying to lengthen maturities on balance sheet (i.e. no reverse twist)”.
On Wednesday, when Powell was asked if he is worried about a crash once he hikes again, Powell replied: "we are in a good place right now”. When asked about low inflation, Powell said: “if you ignore all asset markets, rent, college tuition, medical and food costs, inflation is low. Is that a problem for you?”
Fed’s Powell: “Overarching goal is to sustain the US expansion while keeping jobs market strong. Fed expects the US economy to grow at solid pace in 2019, but data since September shows slower than expected growth and thus we are now patient, which means there’s no need to rush to judgment. It could be some time before outlook calls for policy change. Brexit, trade negotiations pose risks. The B/S reserve balances in September could still be above what's needed for an efficient policy and we have to make additional adjustments to B/S plans if necessary”.
Powell reiterated: “Underlying economic fundamentals are strong and financial conditions are more accommodative compared with a couple of months ago. The data currently is not sending signals on which direction rate policy should move”.
On Wednesday, Fed Chair Powell was asked about the huge anomaly between the White House and Fed projection of GDP growth for 2019. The White House has projected +3% GDP growths for 2019, while the Fed is now projecting significantly lower +2.1%. But Powell refrained from any comments.
Powell added: “Banks are better capitalized compared to pre-crisis and public discussion needs to return to Federal debt sustainability. Fed’s B/S will be around 17% of GDP around end-2019 vs 25% at peak. We haven’t ‘convincingly achieved’ inflation (headline) target in a symmetrical way and not meeting 2% inflation (headline CPI) goal is one of the reasons for being patient. We are not trying to flatten yield curve and will soon turn to a decision on B/S composition. The Fed is unsure how long B/S will remain in the steady state after September”.
Technically, whatever may be the narrative, USDJPY now has to sustain over 112.35-112.50* for a further rally to 112.90*/113.50-114.00/114.25* and 114.50/114.75-115.15/115.50* in the near term (under bullish case scenario).
On the flip side, sustaining below 112.15-111.95/111.25*, USDJPY may fall to 110.80*/110.35 and 110.00/109.70*-109.40/108.50* and further 107.90*/107.50-106.20*/104.70 in the near term (under bear case scenario).
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