On February 1, The Macro Strategist outlined why Fed chair Jerome Powell trapped himself as U.S. macro still remains relatively strong compared to global data.
Furthermore, his weakening stance towards policy did affect the third mandate, U.S. equities, as intended: they're up nearly 20 percent from the December 24th bottom. Financial stress has eased somewhat, too.
It was also pointed out then that eurodollar markets were setting up for U.S. yields to retest the December lows, and they are!
Buy-all-the-things as markets price in zero rate hikes in 2019. As noted earlier in the week, before the FOMC minutes, the probability of yields and the dollar rolling over were rising:
The EDZ 2019 (eurodollar) has tightened after a massive pivot in November, which caused yields to collapse. However, the 7- and 20-day rate of change is beginning to drift higher.
The 7-day ROC is above to flip from negative to positive and could see an inflow into eurodollars. This would be net-negative for the U.S. dollar; 10-year yield would roll over.
U.S. yields are about to retest the December lows.
From the 2-year to 30-year U.S. yield, all have declined approximately 15 bps, from then high, and all are roughly 10 bps from the December low.
On Feb. 1, we correctly pointed out that eurodollars were pricing in ever-increasing dovishness with the EDZ 2020 looking more so, indicating the market believes the Fed will get more dovish.
Despite that, the structural dollar illiquidity have helped keep the reserve currency above 96.5.
Furthermore, if we were to expect that the Fed was truly out of the game, we should expect the yield curve to steepen. Conversely, the 10s/2s curve has meandered near cyclic lows of 11 bps, currently trading at 14 bps.
The end-of-cycle steepening of the curve is initiated once the Fed begins to cut the funds rate and the 2-year yield collapses.
But, the Fed is now looking at a revival of global risk sentiment and eased interest rate pressures.
Cleveland Fed President Loretta Mester said yesterday that she, also, agrees on ending the balance sheet reduction which was hinted may be topic of discussion at today’s FOMC minutes.
The balance sheet reduction, as I stated in 2017, could be net-deflationary (look at credit, risk assets and the dollar) and disrupt global expectations.
It is also a key culprit in reducing the supply of dollar liquidity, which is the lowest it’s been since the sub-prime mortgage crisis.
The problem lies on whether or not the Fed will increase dollar liquidity.
Virtually nobody is showing that base money is contracting nearly 12 percent YoY and its link with interest rates:
U.S. Base Money, YoY (blue); U.S. 10-Year Yield (black)
Furthermore, the U.S. Treasury may keep elevated levels of cash on balance due to the fact that the U.S. government is one of the largest buyers of dollars:
Total U.S. Public Debt YoY (blue); U.S. Treasury Balance (black)
Of course, if the Treasury does unleash liquidity it would impact the dollar, but for how long?
Trade-Weighted Dollar, Major Currencies (green); U.S. Treasury Balances (black)
Today’s FOMC will hopefully provide some clarity to which subscribers will promptly get an outline of expectations. For now, the only thing that’s been consistent is the Fed’s inconsistency.
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