The Fed's Fiscal Reaction Function
Plenty of narratives in the air but as we wrote to clients this week, in looking at multiple markets since the Federal Reserve's Jackson Hole symposium in late August, it's since been largely sideways. Without question the past few months feel and sound like more, but the numbers don't support it. Practically, the Fed has passed the baton short term, the election outcome matters and the fallout from Covid economically still evolving. This is no time for complacency.
Jackson Hole 2020: the Fed's new policy framework. And since then: plethora of speeches, comments, clarifications and coordinated call for a fiscal hand. There has been nothing but fiscal stalemate since the summer. Years, for that matter. And with $3 trillion in the books & $20+ trillion in outstanding marketable debt, the trajectory of our debt to GDP is beginning to look ominous. Covid. Chart below: we've never seen a cross like this in our lifetime.
Nominal GDP $ v Outstanding Marketable US Treasury Debt
Multiple Fed leaders over the past two decades have "warned", but told us "now is not the time to worry". Kick the can down the road. A road which has now led us to Covid and the numbers far bigger. The challenges to growth highlighted in the Fed's new framework. The reality of our fiscal imbalance highlighted in our pro-cyclical spending.
The market has been filled with narratives over the past two months. But, in reality looking across a number of markets, outright levels in many instances have hardly budged.
Chart below: USD (White), CT10 (Green) and the S&P (Purple).
August 27th through today: S&P: 3484-3453 10-year: 75-84 DXY: 93-92.80
And speaking of sideways, lots of questions around the move in rates of late. It's hard not to chuckle a bit: are rates not allowed to move? Who's asking?
60 Seconds on 10-year UST
Amazing, the headlock the Fed put on interest rates in general. If we stay with our prior example of Jackson Hole through today, on the surface 10-year yields are a little over 5-basis points higher within that time frame. But within the context of the broader range & percentage wise, small moves have carried larger weight. Many of the moves occurring in and around long end Treasury supply.
We've been discussing over the past few months the Fed's challenges and merits in doing more. Especially with regard to larger asset purchases with rates and credit spreads already low: Not 2008 long end rates. Not all cash being equal right now.
And the Fed too of late: Very explicit about this theme and in what would appear to be no rush to increase asset purchases. Next steps if needed clearly being discussed. The Fed's balance sheet continues to grow, although the velocity and market impact has slowed.
This Week Chicago Federal Reserve President Evans
“Mortgage rates are low. I just don’t see the same kind of necessity or opportunity like we saw in 2010, 2012, when interest rates were higher and we were really activating the portfolio-balance effect to get it down lower,” “I don’t think there’s a lot of scope for portfolio-balance effect to really lower long-term interest rates a lot because they’re already very low. So, we could try to do more on asset purchases, but I’m not quite sure how far we would get” “Now, we could get to a point where, a little further along, interest rates are higher on the longer end, then there could be an opportunity for doing that. And, maybe we’re closer, we’re within shouting range of 5% on unemployment and we could continue to provide a little more accommodation”
30-year Mortgage Rates
This Week Fed Governor Brainard: Achieving a Broad Based Inclusive Recovery
"In conjunction with the forward guidance on the policy rate, the commitment to continue asset purchases at least at the current pace over coming months is also helping to achieve our goals by keeping borrowing costs low for households and businesses along the yield curve. As noted in the September FOMC minutes, in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation"
For now, outright long end rates and yield curve have taken a breather. We highlight levels along the way (.90, 1% and 1.20% (the March funding squeeze higher)) as levels to watch. The yield curve remains directional and the 10-year is defending levels not seen since June of 2020. Still within the 50-90 basis point range of the past 6 months.
Outright 10-year UST versus the 2/10 UST Yield Curve
The Fed will not let rates runaway, this much we know. But a 25-50 basis point move higher (for the right reasons) will not create a sense of panic. But what will inspire the Fed to react would be a lack of more fiscal liquidity. That is the Fed's very short term reaction function.
Have a great and safe weekend.