The Federal Reserve lowered rates today. At least that’s what they want you to believe. In a sign of just how little confidence the front-end market has in the Fed’s ability to control interest rates, the market is hiking funding rates faster than the Fed can cut them.
Given where futures contracts are currently trading, we can work out where funding spreads are expected to head from now until the end of the month. Specifically, we can work out exactly what the market believes those rates will be for each day between now & then.
(note that the chart is cut off due to the difficulty of fitting the levels we’ve hit over the past 2 days onto the same scale…).
We’re actually settling into a higher range for these funding spreads than we were in the weeks leading up to the Fed’s cut.
Now, it’s likely we could see a slight reprieve tomorrow when the NYFRB publishes their latest release on lending rates – that’s because Wednesday will see an influx of cash from the GSEs which will help offset some of the mayhem created by the confluence of events earlier in the week.
But any suggestion that the Fed can then take their eye off the ball again is nothing more than a trap.
Consider this: very simply given the magnitude of the move implied, the market has already essentially discounted HALF of the Fed’s September rate cut… less than 2 hours after it was delivered!
For the rates themselves, here’s what we know (yellow), along with what 4pm prices implied for the rest of September (flat turn).
In other words, the same kind of “emergency” levels that prompted the Fed to reintroduce open market operations (OMOs) this week (EFFR 10bps+ vs IOER, SOFR 20bps+ vs IOER) are now the market’s BASE CASE for the rest of the month.
The market reaction to the Fed (equities aside.. they’ll get it eventually, but today wasn’t the day) was quite simply what we’re used to seeing in Emerging Markets – when cynicism takes hold before the ink is dry on the central bank’s statement.
QE is coming, in one form or another
More importantly, if there was any thought that OMOs are going to be a short-term fix, forget about it. They’re here to stay. The market has rendered its verdict in unequivocal terms.
Moreover, think about just what a small drop in the bucket a $75bn OMO represents. The SOFR rate yesterday saw a 25th percentile that was 5.00% (and a 99th percentile that was 9.00%!).
The volume associated with those clearing levels? Oh, just $1.177 trillion.
No wonder the market is sharing such a collective chuckle at the idea the Fed can stop the bleeding with a $75bn operation. That still leaves well over $1 trillion to be dealt with.
If you’re wondering what a $1 trillion OMO looks like… well, that my friends is “QE”. It’s about 4x the ECB’s most recent TLTRO.
It’ll be interesting to see where we land tomorrow. The Fed attempted to enforce its will today with another emergency OMO, and while it looks like we might avoid some of the truly horrific prints from Tuesday (aided by the aforementioned influx of cash from the GSEs) – it certainly doesn’t appear all that ails the repo market has been solved.
Now, of course Powell was quick to note that “we’re going to learn a lot more about reserves over the next 6 weeks”. Which is a good thing, because the market is going to force them to. But that’s only if they really admit the problem at hand – which is a serious intensification of reserve scarcity.
Learning on the job
Powell seems to be a fan of “learning about reserves”, he’s said as much in half the press conferences this year.
Well, for funding markets that’s a bit like a surgeon walking into your hospital room just as the anesthesiologist is about to put you under & cheerfully reflecting on just how little they really know.
Here’s a brief synopsis of his greatest hits. Self-deprecating admissions of ignorance are okay sometimes, but not from arguably the most powerful monetary policy official in the world.
But, I guess we’d all feel a lot more comfortable if it wasn’t so obvious that Fed officials know nothing more than the rest of us. And if it wasn’t so patently clear that they’re well-behind on the learning curve while the market continues to punish their developmental delay.
References, Sources : Bloomberg, HFR Research, SocGen Hedge Fund Monitor, CME Group.
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