Is it time for the Fed to shrink its $US4.5 trillion balance sheet?



September 17, 2017 14:09:17

Putting to one side all sorts of worrying messages about risk, Wall Street ploughed on to a record close on Friday and raised the prospects of a solid start to the week for the ASX as well.

Markets on Friday’s close:

  • ASX SPI 200 futures +0.3pc at 5,708, ASX 200 [Friday’s close] -0.8pc at 5,695
  • AUD: 80.01 US cents, 66.98 euro cents, 58.86 British pence, 88.65 Japanese yen, $NZ1.10
  • US: Dow Jones +0.3pc at 22,268, S&P500 +0.2pc at 2,500 NASDAQ +0.3pc at 6,448
  • Europe: FTSE -1.1pc at 7,215 DAX -0.2pc at 12,518 Eurostoxx50 -0.3pc at 3,516
  • Commodities: Brent oil +0.3pc at $US55.62/barrel, Gold -0.8pc at $US1,319/ounce, Iron ore [Nymex] -0.3pc at $US73.70/tonne

The S&P500 hit 2500 points for the first time, the Dow also closed at a new high and the Nasdaq was no laggard either, reaching a record mid-session before a bit of post-prandial profit-taking.

Despite weakness in Europe, the key global index the MSCI — which tracks about 2,400 stocks in 47 countries — ended the week at a new high as well.

All this, despite protagonists on either sides of Korea’s Demilitarised Zone sending some test missiles skywards, the hurricane season rolling on and a pretty disappointing effort by US consumers in August.

It was all just sound and fury, meaning nothing for the markets.

The Fed meets: Big bang or fizzer?

The Federal Reserve’s meeting this week is entirely a different matter.

It will not be a shock if the Fed announces its plans to wind back the $US4.5 trillion worth of assets it has amassed on its balance sheet — up from the less than $US1 trillion before the global financial crisis got cracking a decade ago.

Anxious to avoid the “taper tantrum” of 2013, the Fed has widely telegraphed the move.

Hopefully the market should not be too jittery, but trying to second guess the mass psyche of traders, which is in turn multiplied by algorithmic bots, is a mugs game.

The betting is the Fed will announce it will start reducing its holdings — in effect tapering its reinvestment in Treasury notes and mortgage-backed securities (MBS) — next month.

This should allow the Fed to put tapering on autopilot without being distracted by the recent trend “choppy data” flowing through.

It should also give it time to assess the market’s mood — among other things — before deciding whether to raise rates again in December.

A decision to hike again at this meeting, while announcing the start of tapering, is probably too much for markets to digest at one time.

Fear the taper?

The Fed’s musing about tapering in 2013 didn’t go well. It was all just fear. Nothing happened, then the Fed backed away and basically kicked the can down the road to this week.

Certainly, long-term interest rates will rise and one of the worries is the US economy’s recovery will be stifled as credit becomes tighter.

A softer US dollar will likely weaken further. That’s probably not great news for the Australian dollar which has pushed through 80 US cents.

The $US1.8 trillion MBS the Fed holds naturally amortise at 1 per cent a month, so they should roll off under a $US20 billion monthly cap the Fed has set.

The $US2.5 trillion in Treasury notes should also decline at somewhere around 10 per cent a year as well. So it is a drawn out process.

The problem is the Fed has a massive position in the market and, as Macquarie Bank recently pointed out, about $US400 trillion of other assets around the world are linked to the big four central banks’ bloated balance sheets.

The unknown is to what extent markets have become addicted to the easy money. Withdrawal symptoms can be very, very ugly.

The Fed’s balance sheet is unlikely to shrink back to pre-GFC levels, because just as its assets swelled, so did its liabilities.

The money printing, the hoovering up toxic debt from the sub-prime lending binge as well as long-tailed government debt means much bigger balance sheets are the new normal for central banks.

Just as an aside, the Fed as the biggest dealer on street has made somewhere well north of $250 billion from its MBS portfolio.

That has in turn been handed back as a nice little earner for the ultimate supplier in the trade — the cash-strapped US Federal Treasury.

Nothing has gone that smoothly in the central banking world since the GFC. There is little reason to believe the taper will be the exception to that rule.

Quiet week ahead

Assuming the taper announcement is not too far off expectations and one of the missile tests is not a fail on a disastrous scale, it is shaping up to be a quiet week.

Data and the calendar here and overseas is all very ho-hum.

One interesting item maybe the OPEC meeting in Vienna on Wednesday assessing how the self-imposed 1.8 million a barrel a day cut in oil production is going.

Compliance had edged up above 100 per cent, while global inventories slipped.

At the same time, demand forecasts supplied by the International Energy Agency have been edged up.

With oil prices holding above $US50 a barrel, OPEC will probably be pretty pleased with things so far.


Date Event Forecast



New vehicle sales Aug: Fell in July, but still solid



RBA minutes Insight into August hold. Board seems reasonably happy with things
House price index Q2: ABS measure, like to cool from 10pc in Q1
TPG FY result Underlying profit of $420m forecast, interest NBN comments & mobile sales



RBA speech Asst. gov. Luci Ellis talks to business economists
Skilled vacancies Aug: Only for the hard-core macro watchers



RBA speech Governor Philp Lowe in Perth



APA FY results Another solid performance for the pipeline operator expected


Date Event Forecast



CH: Property prices Aug: Bubble like in major cities, no signs of bursting just yet
EU: Inflation Aug: Still very weak around 1.2 YoY



US: Housing starts, building permits Aug: Both probably flat after July’s slide
US: Current account Aug: Still a big deficit around $US110bn



US: Fed rate meeting An announcement on tapering expected but not rate hike
EU: OPEC meeting Meeting in Vienna for an update on the production cut deal



EU: ECB speech President Mario Draghi in Germany



EU: PMIs Sep: Readings of both manufacturing and services activity, both solid








First posted

September 17, 2017 13:58:39

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