Higher (Real Rates) For Longer

Published on February 20, 2024 by Premium

The recent bout of higher inflation prints and resurgent labor market strength changes the timing and number of rate cuts, but does not change the direction of monetary policy. Fed officials note the risks between their employment and inflation mandates are more balanced, so they are increasingly mindful of potential overtightening. Fed officials have widely articulated a framework that views policy through the lens of real interest rates and a neutral rate that is little

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Sea Change

Published on February 12, 2024 by Premium

The CBO's latest budget forecast show a persistently large fiscal deficit that likely still understates the trajectory of public finances. CBO projections are based on current law and show a fiscal deficit that will remain around 5% of GDP for the foreseeable future. This structural change is largely driven by rising retirement related spending and interest expense, both of which are politically very difficult to change. Using the CBO projections as a baseline, future deficits

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Levering Up

Published on February 5, 2024 by Premium

The large supply of Treasuries continues to be absorbed by the cash-futures basis trade, but new research is revealing some of the drivers behind the trade that shed light on its potential limits. Circumstantial evidence suggest that the cash-futures basis trade has surged to all time highs in line with ongoing growth in coupon issuance. While the trade depends on the capacity and willingness of dealers and hedge funds, it also depends on continued investment

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Passing the Buck

Published on January 29, 2024 by Premium

The Treasury has an opportunity to lobby the Fed for an earlier QT taper by both rapidly draining the RRP and pushing up repo rates through further increases in net bill issuance. While Congress determines the size of the fiscal deficit, the Treasury and Fed together determine the supply of duration to private investors. The Fed has increased the overall level of issuance to private investors through quantitative tightening, but Treasury has cushioned the market

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Token Resistance

Published on January 22, 2024 by Premium

Fed officials are unlikely to meaningfully push back against the market's aggressive pricing of rate cuts regardless of the rise of risk assets. Real rates remain at cycle highs from declining inflation expectations even as recent inflation data is very close to 2%. Fed officials perceive financial conditions to be restrictive even with six rate cuts priced in the market, and are also concerned with potentially overtightening. The high degree of uncertainty and the Fed's

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The QT Debates

Published on January 16, 2024 by Premium

Fed officials are planning to taper QT, but have expressed a range of views that place a taper anywhere from this quarter to much later. In the absence of a rise unemployment, the path of QT will be guided by the amount of liquidity in the financial system. However, Fed officials have expressed disagreement on which components of liquidity to emphasize. They have focused on RRP levels, reserve levels, or the consolidated level of the

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Doves Ascendent

Published on January 8, 2024 by Premium

Monetary policy going forward will be increasingly biased towards rate cuts as both inflation has declined and employment growth appears to be slowing. Policymakers set policy with an eye towards a trade-off between employment and inflation, with the balancing of risks dependent upon the policymaker's values. The record of the current Fed leadership and political donations of Fed staff indicate a left leaning preference, suggesting an emphasis on employment over inflation. While the Fed is

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Transitory Disinflation

Published on January 2, 2024 by Premium

Inflation declined rapidly largely due to onetime supply side improvements and will likely resurface as easing financial conditions rekindle demand. Improving supply chains and increases in labor force participation played a major role in moderating inflation by increasing the overall supply of goods and services. The Fed's restrictive policy also played a role by having some impact in dampening overall demand, but that policy in the process of being unwound. Household purchasing power remains very

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Independent Tracks

Published on December 18, 2023 by Premium

Chair Powell's intention to separate interest rate and balance sheet policy will likely extend quantitative tightening to well into 2025. The Fed has historically linked their interest rate and balance sheet policy together so that the two have always moved in the same direction. But Chair Powell appears to endorse the view that QT can continue when rate cuts are intended to normalize interest rates rather than to add accommodation. With current policy perceived to

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Reflexivity

Published on December 11, 2023 by Premium

A sharp decline in interest rates in benign economic conditions opens up the possibility of a re-acceleration in economic activity that would limit the number of future Fed cuts. One mechanism through which higher interest rates slow the economy is through reduced lending, where higher rates discourage borrowers and prompt lenders to retrench on credit concerns. Despite an aggressive rise in rates, a wide range of measures on credit quality show only modest deterioration to

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