A case for the Fed to sell some bonds


Another Fed meeting, another chance to set up expectations for an eventual move higher in interest rates.    On an exclusive basis, Macro Man is pleased to be able to provide readers with a photo of today's FOMC deliberations.    If you look closely, you can see the agenda for the September meeting being established to the left, with one FOMC member already preparing to slap down any expectations arising from today's announcement at the first sign of trouble (or what the committee defines as trouble, which may not fit your own definition.)

Leaving aside the dreary will they/won't they farce that has dominated Fed rhetoric for the past eighteen months or so, another questions arises: why doesn't the Fed just sell some bonds?  After all, the original exit plan established early in the decade envisaged selling bonds as a precursor to raising rates, though that was eventually scrapped after the Fed snaffled another trillion or two of securities.

From Macro Man's perch, shifting the policy focus to selling bonds could offer a few benefits, including the following:

* By reducing the level of excess reserves, it would accelerate the timetable for a normalization of the level of reserves, potentially allowing the Fed to regain greater control of money market conditions using conventional (and less politically sensitive) tools

* By the same token, the extremely high level of current excess reserves should prevent an undesired tightening of conditions in the front end.  Yes, repo rates would likely rise, but a modest increase there should not incur undue concern

* It would increase the amount of high quality collateral on the street.   The monetary policy focus of many central banks since the crisis, including each of the G3, has been to purchase enormous amounts of government debt, effectively removing it from circulation.  In a post Lehman world, this type of high quality debt is the collateral that greases the rails for global financial transactions, all the more so because most intermediaries can no longer rehypothecate this collateral.   Providing more collateral to the world market (thereby offsetting that taken away by the ESCB and BOJ) can only be a good thing

*  At the same time, providing more high positively yielding instruments to the private sector would convey signal benefits to a yield-starved world.   While it may be the case that a bond-auction program could push Treasury yields higher, it seems unlikely that global savers will sit idly by earning sweet FA in Bunds as US 10's back up 100 basis points

* However, a modest rise in longer term rates may convey benefits beyond those to yield-starved savers.  A modest steepening of the yield curve should be good for financial earning power.   While this may be anathema to the likes of Elizabeth Warren, perhaps she should ask Europe how they're getting along with a banking sector that makes no money

* Just as importantly, higher long term rates actively helps pension funds via reducing ALM burdens and increasing the returns available from fixed income portfolios

* While it is true that higher mortgage rates are not good for housing, Macro Man's analysis suggests that changes is home sales are somewhat less responsive to changes in mortgage rates than they were before the crisis.

* Perhaps most importantly of all, implementing a regular auction program will enable the Fed to reap the benefits of more "free easing" simply by reducing or even stopping the program.   Who needs the dots when you can just reduce a bond auction?
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Anonymous
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July 27, 2016 at 7:46 AM ×

Why would the Fed sell bonds, when the BOJ is about to monetize all it's debt (see WSJ), forcing a huge surge in the USD, killing US exports and causing a downturn in the SP500, at which point the Fed will be forced to launch QE4?

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Spctr
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July 27, 2016 at 12:05 PM ×

The Fed's headache!
Winding down a bloated balance sheet at the risk of sparking the next recession through higher Greenbacks!
Chairwoman Yellen is an Okun pupil, thus her willingness to run the economy "hot" before engaging in any meaningful hawkish monetary policy.
By then, President Trump should be in a position to engage a massive fiscal stimulus by importing a 100M Chinese workers into prefab Trump cities and factories across the midwest to rejig Made in USA with the caveat of keeping Chinese wages.


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Leftback
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July 27, 2016 at 12:13 PM ×

Very reasonable idea, MM. I like it, it's been discussed here several times, and it makes more sense to use this nuanced mode of tightening, but it isn't going to happen for two reasons: First, Bernanke said long ago that the balance sheet would be reduced simply by letting the bonds mature, and Dame Janet will not contradict him; Secondly given the Yellen Fed's obsession with telegraphing its moves ahead of time, a Summer Surprise of this type seems unlikely. More chance that we will see them slide the dots to the left and upwards a bit. Expectations of any form of hawkish move are still remarkably low, almost as though the market thinks the Fed simply put the statement and dot plots into cryostasis and went home.

With markets where they are, and leveraged longs and vol sellers simply taking the piss, this seems like as good time as any for both Dame Janet to talk a little tougher (laughable I know) and BoJ to hold off with the most extreme measures until stimulus is more urgently needed? We see both DX and JPYUSD stronger by the end of the week. Easing aggressively here makes little sense. It costs Yellen nothing to hint at September now and then take it back again if Spoos drop 3% and they deem it necessary. As for Kuroda, he isn't going all-in here, so most punters are probably getting ahead of themselves. Nuclear monetization and currency collapse stories are fun for economic apocalypse blogs but we are simply not there.

Crude has broken below $43/bbl. Sell the rips..... if there are any, it's going lower on supply glut, softening demand and a firmer dollar, and at some point in the not too distant future it will start to thrash around in the water and take high yield and equities under along with it.

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Anonymous
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July 27, 2016 at 2:09 PM ×

There's nothing excess about "excess reserves", they now form a critical part of banks' HQLA portfolio. We're still in financial repression and until that changes, leading to a significant change/increase in issuance dynamics, I don't see a reduction in the fed b/s full stop.
Amount of punters re-interpreting the libor move as a hike reprice is mystifying to me. What's ur 2c on the BoJ (and poss coordination with the MoF?).
Thanks
JL

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12yo HFM
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July 27, 2016 at 3:16 PM ×

Still on bae-cation, but thought I'd share my FOMC views with you bros. I'm expecting the statement to read like "blahblah no change". Obvs this is HIGHLY bullish for equities, so we remain positioned long. I appreciate risk management is paramount in this job so I won't be in the pool during FOMC, but will standby at the bar ready to buy more SPX if there's anything even resembling a dip.

TL;DR Get long equities #YOLO

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patrick
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July 27, 2016 at 3:31 PM ×

http://www.ft.com/cms/s/0/947ad9b6-534d-11e6-befd-2fc0c26b3c60.html#axzz4FcSdDtIy

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TraderJim
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July 27, 2016 at 5:16 PM ×

Positions this week, short Crude, Short Spooz, Long USDEUR. Thinking on Crude is a lot of noise on inventory not reducing in the US at the moment. Spooz and USD position on likely Fed slight 'drift' to Dec tightening talk.

Crude done ok so far. Spooz and USDEUR flat.

Can't believe VIX is 11.09 I want to buy spot as a play for the next random event

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abee crombie
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July 27, 2016 at 5:25 PM ×

Yellen and the rest of Fed are worthless. They only know one reaction function... to ease!

They will lose all credibility when inflation really comes in a few years (for a number of reasons) and even then it will be a while before the market realizes what a giant mess fiat CB have done. But until then same old rules. Play cyclical economic cycles & technicals

Will be interesting to see if sagacious LB is correct with HY. If it indeed does start to follow could get interesting. Frankly most of the bonds I am looking at in HY space are just too darn expensive here even if the index isnt anywhere near the 2014 highs...

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johno
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July 27, 2016 at 5:35 PM ×

Good call on oil, LB. In retrospect, the loss of momentum in timespreads and bottoming action in the dollar were give-aways. For my part, I cut away petro-currency exposures before they backed up, but didn't put on any short oil exposure. For choice, I think I'd rather be short oil futures than CAD as the latter is looking cheap to oil and rate differentials.

Sitting quite flat here, though assets 100% USD-denominated. There are compelling narratives on both sides of most things I'm looking at right now, and price action isn't tipping one way or the other. PLNHUF might be interesting if there's a clear break through 72.

Historically, August is a bad month for carry trades and they've come a long way this year, so I'm reluctant to push that bet. It was interesting to see carry, especially NZD and AUD, get bid yesterday when JPY was strengthening. One typically thinks of those as negatively correlated, but if not set against a risk-off environment, maybe there's a case for positive correlation. Especially with JPY now getting close to 100, Japanese lifers may be more willing to do un-hedged investing. The FY16 investment plans of Nissan, Dai-ichi, Sumitomo, and Meiji Yasuda saw USDJPY in 110-120, 100-120-, 100-125, and 103-119 ranges, respectively, so JPY may now be starting to look expensive to them. That might put some floor under USDJPY and might also keep currencies like NZD and AUD higher than you'd expect given rate cutting cycles in each. There are lots of high yielding assets in those countries ...

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MrBeach
admin
July 27, 2016 at 6:40 PM ×

Meanwhile, Japan is considering issuing 50 year bonds. France and Spain are already on that train.

"France and Spain sold 50-year government bonds this year, letting them lock in relatively low borrowing rates through the 2060s. The French government will pay a coupon of just 1.75%, and strong demand means the yield is even less—1.3%—for investors who buy those 50-year bonds now on the secondary market."

If the BoJ buys Japanese 50 year bonds at near zero rates, this is pretty darn close to Helicopter Money.

Is this really the future? ZIRP and long term bonds holding up all asset markets forever. Has 12 HFM has seen the future?

http://www.wsj.com/articles/japan-govt-mulling-issuance-of-50-year-debt-sources-1469589748



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Anonymous
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July 27, 2016 at 7:10 PM ×

Mr Beach., are you suggesting that asset prices have reached what looks like a permanently high plateau ? :D

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Polemic
admin
July 27, 2016 at 11:57 PM ×

i suggest you get Buba to go first.

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Corey
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July 28, 2016 at 1:07 AM ×

Great idea MM, but where is your econometric model proving this, you know the fed are data dependent?!

Wowza, statement sounded like it was written be 12yo hf, but dat mkt reaction tho.

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