First is a reminder from MS that the devil is ALWAYS in the details, and in defense of having modified year ahead outlook just a few weeks in),
The first two weeks of the year have reinforced the key message from our 2022 Strategy Outlook – the policy training wheels are indeed coming off, and fast! The hawkish shift in the minutes of the FOMC’s December meeting, reinforced by the rhetoric from a number of Fed officials, signals policy tightening through more hikes. They are coming sooner than expected, and the timeline between the first rate hike and the beginning of balance sheet runoff will be compressed. Our economists now expect the Fed to deliver four 25bp hikes this year, at its March, June, September, and December meetings, in addition to an August start for the balance sheet runoff announced last July (see More Tightening Than You Think). Market pricing already reflects this hawkish shift, with the March liftoff nearly fully priced in along with 3-4 hikes in the subsequent 12 months.
Given the size of the Fed’s balance sheet (US$8.2 trillion, consisting of US$5.6 trillion in Treasuries of varying maturities and US$2.6 trillion of agency MBS), the runoff has important market implications. However, quantifying its impact is far from straightforward. One could look to the balance sheet expansion in the post-GFC years with the view that if the buildup lowered interest rates, the runoff should have the opposite effect. A rule of thumb (with a lot of hand-waving) suggests a 4-6bp change in the 10-year interest rate from a US$100 billion change in the balance sheet. However, we would argue that the market effects are unlikely to be symmetric and a simple sign reversal between the buildup and the runoff ignores the complexity of the modalities. We expect different impacts for Treasuries and agency MBS, given the different ways they were acquired during the buildup and the share of the Fed’s holdings in their respective markets.
…Our interest rate strategists estimate that US Treasury issuance needs will rise by ~US$850 billion by the end of 2023 and ~US$1,300 billion by the end of 2024. If we assume that the Treasury follows the advice of the Treasury Borrowing Advisory Committee, the optimal targets for increased issuance would be at the 7-year and 10-year points of the yield curve. Consequently, our strategists now forecast 10-year rates to reach 2.30% by the end of 2022.
The story with agency MBS is quite different…
… Of course, the markets have already begun to price in some of these effects, as mortgage spreads have widened about 20bp in the last two weeks. Still, our agency MBS strategists have advocated being short the mortgage basis for some time, and they think there is still room for modest widening (~10bp) in the mortgage basis from here, with mortgage rates rising towards 4%.
Do not underestimate the effects of liquidity withdrawal.The mammoth balance sheet the Fed has built up was a key determinant of liquidity across markets. As balance sheet runoff is put into motion, the withdrawal of liquidity will have profound impacts. Determining how it plays out is far from straightforward and will be determined by a variety of factors. Understanding the details matters. So hold on tight – there’s volatility ahead.
Assume. NOW f’cast. DON’T UNDERESTIMATE EFFECTS OF LIQUIDITY WITHDRAWAL … yet it seems to me that is precisely what Global Wall Street CONTINUES to do. These are ALL words of a marketing machine of Global Wall Street who have no clue.
Neither do I but I’m not paid to and even when I was more marginally attached TO markets (so, in a way PAID to), was willing to admit the limits of ability.
Today’s story is about patience. Whether you are trading or investing, 2022 will require more calm thoughtfulness than any year in recent memory. History shows that as crises fade into the rearview mirror, market volatility (and the opportunities it brings) declines. Also, there is a real tug of war now between fundamentals and Fed policy. Lastly, the best places to make money in stocks (cyclicals, in our view) are volatile and rarely well-structured industries or companies. Bottom line: 2022 is a “measure twice, cut one” sort of year.
While not directly mentioning this weeks 20yy auction, this was the point I tried to convey (yesterday).
Sometimes the best trades are the ones never made (covering a short duration position early on in the year, for example…).
Couple more things then I’m outta here — I promise.
AND there’s this update from yesterday afternoon regarding UST market in the case you’ve not YET gotten your fill of QT and balance sheet shrink’flation
Fed’s taper begins to bite next week as purchases dwindle
Treasury Department mulls changes to issuance patterns
January 15, 2022, 4:00 PM EST
The Treasury market is facing a patch of supply-related cross-currents that may complicate the path for yields as they move higher.
… Increasing the pace at which the Fed dials back its bond buying “is akin to loosening the nuts on the training wheels and the bike will be a little more wobbly for the market to ride,” said William O’Donnell, strategist at Citi. “In March the training wheels come off. The question is how much of the Fed buying less Treasuries is already priced in by the market given the rise in yields we have seen so far this year.”
The Fed’s latest tapered purchase schedule includes 10 operations from Jan. 18 to Feb. 10. Previous monthly schedules have had 18 operations, typically one each trading day …
… “On balance we can expect more volatile coupon auctions as there will effectively be more supply for the market to buy,” O’Donnell said.
The 10-year yield ended Friday at 1.78%, notching its fourth straight weekly increase. Treasuries have lost 1.8% so far this year, on top of a 2.3% loss last year, the first annual decline since 2013, based on the Bloomberg Treasury Index …
… The prospect of the Fed allowing some of its Treasury holdings to mature probably won’t forestall auction size cuts in February, but it makes subsequent reductions less likely, said Lou Crandall, chief economist at Wrightson ICAP LLC.
Then there’s THIS IN BARRONS (buried by the roundtable — rates going up — lead),
… To rein in inflation, the Fed’s monetary expansion will have to slow and eventually reverse. As the central bank stops buying and starts redeeming maturing securities, J.P. Morgan estimates the market will have to absorb an additional $350 billion in bonds this year. Slower growth in the money supply will leave less excess cash available to be plowed into equities, according to a report by Nikolaos Panigirtzoglou, head of the bank’s global quantitative and derivatives strategy group.
This prospect of tighter liquidity already is making for a miserable start to 2022. It may be just beginning.
And finally, I couldn’t resist a few ‘toons via TownHall
Thats IT. I’m off to pregame in the family room … Economic indicators for the week ahead are set to go out before tonight’s open ahead of extended weekend…Stay safe and enjoy the games!
