SPY & The Quad Witching (June 17th)

[juangomez053]

Looking at CPI, most of what drove inflation was supply side. There is a case to be made that 50 is reasonable due to the Fed being able to do fuck-all when it comes to supply-side constraints and demand being destroyed already with inflation as is plus already relatively tightening financial conditions due to high rates.

I’m not going to be on much during FOMC tomorrow due to some personal stuff going on (everything is fine, just have an appointment I can’t move). These are the things I would be looking for when FOMC comes out tomorrow:

1. 50 or 75 hike (obviously)

2. Will we get a terminal rate forecast?

Futures are forecasting 4.00% by March 2023 to be terminal rate.

3. Will Powell pull a Volcker and stop the forecasts all together (most likely not, they’ll prob start trying to be even more open than they are already about everything and being more hawkish than before)?

4. Will there be a change in how Balance Sheet roll-off is done? We already got research from the Fed saying it doesn’t really make a difference if they ease into full cap monthly roll-offs or if the incrementally raise the caps:

Stagflation leading to Recession - The Kodiak Bear Thesis

New Fed note about Balance Sheet reduction’s effects on economic policy came out yesterday. The main point of the note seems to be that a reduction of $2.5 Trillion is equal to a FFR hike of about 50 bps, which seems really low but in line with what Fed Governor’s have been saying recently. FED’S DALY: I SEE THE BALANCE SHEET TRIMMING DELIVERING ABOUT 25 BPS OR 50 BPS OF TIGHTENING. FED’S WALLER: BALANCE-SHEET REDUCTION IS COMPARABLE TO 1.5 TO 2.5 25-BPS INTEREST RATE HIKES. First a primer on the Fed’s tools and what they do: “Policy rate actions and communications influence the economy by affecting the cost of short-term borrowing and expectations about the path of short-term interest rates. Balance sheet policies primarily influence the term premiums embedded in medium- to longer-term yields by changing the supply—current and expected—of longer-term securities held by the public.” How does the model work? The model manipulates nominal ten-year yields and reductions of Ten-Year bonds from the balance sheet and equating these manipulations to a certain raise in the FFR. “The model implies that a one-time permanent reduction in the Federal Reserve’s holdings of 10-year equivalent Treasury securities equal to 1 percent of nominal GDP raises the term premium on a 10-year Treasury security by about 10 basis points, all else equal. In the model, this amount of policy tightening can also be achieved by raising the average expected path of the federal funds rate over the coming decade by about 10 basis points.” The model uses three scenarios, a baseline, a no runoff scenario, and a full runoff scenario: “Baseline: Shrink the balance sheet starting in June 2022 in a manner consistent with the FOMC’s Plans for Reducing the Size of the Federal Reserve’s Balance Sheet, as captured by the illustrative baseline balance sheet scenario featured in the 2021 SOMA annual report. After a three-month phase-in period, let up to $60 billion in Treasury securities and up to $35 billion in agency MBS run off the balance sheet per month.” “No runoff: Keep the balance sheet size constant in dollar terms by rolling over Treasury securities and agency MBS until growth in the demand for Federal Reserve liabilities provides a basis for resuming organic growth of the balance sheet.” “Full runoff: Shrink the balance sheet through the full runoff of all Treasury securities as well as maturing and prepaid agency MBS starting in June 2022, without any phase-in period (about $105 billion per month, on average over the runoff period).” What I found interesting was that the difference in the economic impact between gradually increasing the amount of run-off per month (baseline scenario) and starting run-off at full capacity (full runoff) was relatively small. [image] What was also interesting was the relationship between the FFR and the Ten-Year term premiums/Yield Curve: “The differences in policy rate paths across scenarios are roughly equal (but with an opposite …

5. Will we get some sort of statement on the Fed Put?

6. Will we get some sort of statement on credit markets? (No-bids on MBS, high yield spreads widening, etc.)