The Hard Way

The quarter has come to an end
And Brexit’s now just round the bend
Meanwhile Chairman Jay
Has learned the hard way
Experience is his best friend

It has been more than a week and the market continues to talk about the liquidity crunch that drove repo rates to 10.0% briefly. The Fed did respond, albeit somewhat slowly, and have seemingly been able to get things under control at this point. But in the WSJ this weekend there was a very interesting article asking, how could this have happened? After all, the Fed’s primary responsibility is to ensure that there is sufficient funding in the system. And I think for all market participants, this is a critical question. Since the Fed is essentially the world’s central bank, if they are losing control of the plumbing of the US money markets, what does that say about their ability to implement monetary policy effectively.

The back story revolves around actions that occurred shortly after John Williams was named NY Fed President, despite a complete lack of markets experience (he is a PhD Economist and Fed lifer, never having held a job in the private sector). In one of his first acts, he dismissed two key lieutenants, the head of the Markets Desk and the head of Financial Services, both of whom had been with the Fed for more than twenty years, and both of whom had intimate familiarity with market crises. After all, they were both in their roles during the Financial crisis, when Williams was one of a hundred economists working for the Fed’s Board of Governors. In other words, he has zero real world or market experience, and he fired the two most experienced market hands in his organization. While there has never been an explanation as to why he made that move, it clearly came back to haunt him, and the Fed at large, last week.

The issue for markets is now one of confidence. It doesn’t matter that things seem to be under control at this point, and all the talk of a standing repo facility being implemented to insure there is always sufficient liquidity are addressing the symptoms, not the cause. In addition, there is almost no question that the Fed is going to start rebuilding its balance sheet, as apparently, watching that paint dry was a bit more exciting than anticipated. But in the end, if market participants lose faith that the Fed can effectively manage its processes, then it will significantly change the overall atmosphere in markets. Remember, we have spent the last ten plus years being taught that central banks, and the Fed in particular, have one job, to protect financial markets. Two weeks ago, we realized that the ECB has basically run out of ammunition in its efforts to continue to address Europe’s problems. If the Fed has lost the knowhow regarding what is needed to manage the US financial system, that is a MUCH larger problem. I’m not saying they have, just that the repo market gyrations are an indication that they will have to work very hard to convince markets they are still in charge.

Turning to the market situation overnight, there has been very little of interest overall. In fact, the best way to describe things would be mixed. For example, the dollar is slightly firmer vs. the euro (+0.15%) but slightly weaker vs the pound (-0.15%). And the truth is, as I look across the board, that is a pretty good description of the entire FX market, modest gains and losses without any trend to note. European equity markets are little changed, US futures are the same and Asian markets were mixed (Nikkei -0.5%, Hang Seng +0.5%). Finally, bond markets have shown almost no movement with 10-year yields in the major bonds within 1 basis point of Friday’s levels.

As today is quarter end, it feels like most market participants have already straightened up their positions and are waiting for tomorrow to start anew. Meanwhile, we have seen a bunch of data, with the most noteworthy so far being the very slightly better than expected Chinese PMI data, with Manufacturing PMI printing at 49.8 vs. expectations at 49.6. So, while that is better than a further decline, it still points to contraction and slowing growth in China.

Looking ahead to today’s session and the week upcoming, though, there is a lot of new information on the way, including the payroll report on Friday.

Today Chicago PMI 50.0
Tuesday ISM Manufacturing 51.0
  ISM Prices Paid 50.5
Wednesday ADP Employment 140K
Thursday Initial Claims 215K
  Factory Orders -0.3%
  ISM Non-Manufacturing 55.1
Friday Nonfarm Payrolls 146K
  Private Payrolls 130K
  Manufacturing Payrolls 3K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Participation Rate 63.2%
  Trade Balance -$54.5B

In addition to the payroll report, we have fourteen Fed speakers, essentially the entire FOMC, this week. My conclusion from this excessive schedule is that the Fed is very concerned that their message is not getting across effectively and that they feel compelled to clarify and repeat the message. However, given the wide disparity of opinions on the Board, my sense is this onslaught of speeches will simply add to the confusion. Chairman Powell has a tough road ahead to get his views accepted given what seem to be hardening positions on both sides of the argument. In fact, the only way the doves can win out, in my view, is if the economic data here starts to deteriorate significantly, but of course, that is not an outcome they seek either!

As to the dollar, there is nothing that has occurred anywhere to dissuade me from my ongoing bullish view. Until we see some more significant changes in the data, the dollar will remain top dog.

Good luck