Today brings a 2nd day of congressional testimony with Fed Chair Powell, this time before the House Financial Services Committee.  The economic IQ varies widely among those committee members.  While we'll no doubt hear some hilariously bad or irrelevant questions, there's always a chance that a thought-provoking question elicits a relevant response from Powell.  

If I were a member of the House FSOC (shudder), I would have been left wanting yesterday with respect to Powell's treatment of the balance sheet question.  He basically "got away" with saying "we're now in a position to evaluate the appropriate timing and approach for ending the balance sheet run-off" without being pressed further. 

Why press further?  Because the end of the balance sheet run-off is hugely important!  In my view, it's one of the reasons bonds have been able to hold near longer-term lows even as stocks have recaptured much of their late-2018 losses.  In fact, before the January 30th Fed Announcement, there's no guarantee that bonds would NOT have continued trending higher in 2019, nor is there a guarantee stocks would have pulled up and out of their first post-bounce consolidation pattern.

2019-2-27 NL4

As a remind, in his Jan 30th press conference, Powell said:

  • FED HAS MADE FUNDAMENTAL DECISION TO CONTINUE USING AMPLE SUPPLY OF RESERVES
  • FED DISCUSSIONS WILL SOON TURN TO ULTIMATE COMPOSITION OF FED'S BALANCE SHEET
  • FED WILL BE FINALIZING BALANCE SHEET PLANS AT COMING MEETINGS
  • TO COMBAT A FUTURE ECONOMIC DOWNTURN, BALANCE SHEET WOULD BE USED TO STIMULATE ECONOMY AFTER USING INTEREST RATE TOOLS

Since then, we've heard widespread confirmation from other Fed members that the balance sheet run-off will have a much shorter life span than previously thought.  For instance, numbers of $2-3 trillion were being thrown around about a year ago when it came to the point at which the balance sheet would level off.  It's barely under $4 trillion now and the Fed suddenly seems eager to prevent it falling much more than that.  If they let the run-off continue all year and end it in December (they love to make big changes in December), it would still be well over $3 trillion.

A $3 trillion balance sheet is not something the bond market expected it would be able to enjoy indefinitely.  Why "enjoy?"  Because most of that $3 trillion would be in bonds that are constantly receiving principal payments, and if the Fed is holding the balance sheet steady, those principal payments are reinvested back into the bond market.  In other words, the Fed would once again be the world's biggest buyer of US government debt.  That's plenty of justification for bonds to be gaining at the same time as stocks.

If I were an exceptionally intelligent member of the House FSOC, I might go so far as to ask Powell for more info on Fed Vice Chair Clarida's comments last week about capping Treasury yields and how the Fed will be assessing the efficacy of bond-buying programs in staving off low inflation.  When Clarida said that, I immediately thought of the following chart which any decent analyst is well aware of.  It shows unequivocally that QE works.  By the time markets saw the Fed was willing to give them QE3, inflation panic was over.  Meanwhile, the EU showed us what inflation panic could continue to look like without QE. 

2019-2-27 open

In other words, there's only one conclusion to Clarida's proposed assessment.  QE works and if inflation falters, we can expect the Fed to ratchet the balance sheet right back up and over $4 trillion.  To recap: bonds are going to get much more guaranteed buying than they were expecting at some point in the next 9 months, and they have an additional chance at getting an even bigger injection of buying demand as soon as this economic cycle finally begins to shift.  


MBS Pricing Snapshot
Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.
MBS
FNMA 3.5
100-08 : -0-05
Treasuries
10 YR
2.6730 : +0.0370
Pricing as of 2/27/19 9:50AMEST

Tomorrow's Economic Calendar
Time Event Period Forecast Prior
Wednesday, Feb 27
10:00 Pending Sales Index Jan 99.0
10:00 Pending Home Sales (%) Jan 0.4 -2.2
10:00 Factory orders mm (%) Dec 0.5 -0.6
10:00 Fed Chair Powell Congressional Testimony *