One of the things I’ve been vocal about is the Fed’s inability to be able to sustain interest rates, and their backing off from the current “tightening regime.” Yes, I put tightening in quotes because the Fed is not really tightening monetary policy, as monetary is already tight.
Though I agree with you that the Fed will eventually back down, but the biggest question is when. Last time, they raised rates to 2.5% before starting another QE. This time they are "targeting" a neutral rate, which is around 2.5-3% as of now.
Will a "crisis" in European bonds or a currency crisis in Asia lead them to back off? The USD shortage and the weakness in the yen and euro have huge implications for weaker economies with low forex. The crisis this time will be elsewhere for sure, but the response of the Fed will be keenly watched (another QE or just a halt of QT and hiking rates).
My thesis has been that they will back off in September after the break in August. I was looking, and wanted to include in this article but did not want to make it too long Eurodollar futures vs implied hike spread. Last week before the 75bps it was assuming 99bps between now and year end. Now it seems to be pricing in another 75bps before end of 2022. So I think they hike again next month, and then cut.
This leads to the crisis in Europe. A lack of dollar liquidity is a big issue for European banks especially, as they use USD to fund a lot of their long term investment portfolios. The fact that the basis on the G7 simple average is moving lower, and is much lower than it was in 2018 is telling. In 2018 the basis was still negative on the swap so it did imply some sort of dollar shortage, and bank credit risk being added to that premium. However, it is nothing like it is now, and we are moving towards averages we did not see since the beginning of the pandemic. This leads me to the conclusion that this is much worse than it was last hiking cycle. As you mentioned weaker economies with lower forex spot rates is going to cause a lot of pain for many of these countries.
intersting. thanks for posting
Great Explanation!
Though I agree with you that the Fed will eventually back down, but the biggest question is when. Last time, they raised rates to 2.5% before starting another QE. This time they are "targeting" a neutral rate, which is around 2.5-3% as of now.
Will a "crisis" in European bonds or a currency crisis in Asia lead them to back off? The USD shortage and the weakness in the yen and euro have huge implications for weaker economies with low forex. The crisis this time will be elsewhere for sure, but the response of the Fed will be keenly watched (another QE or just a halt of QT and hiking rates).
Hello Sagar,
My thesis has been that they will back off in September after the break in August. I was looking, and wanted to include in this article but did not want to make it too long Eurodollar futures vs implied hike spread. Last week before the 75bps it was assuming 99bps between now and year end. Now it seems to be pricing in another 75bps before end of 2022. So I think they hike again next month, and then cut.
This leads to the crisis in Europe. A lack of dollar liquidity is a big issue for European banks especially, as they use USD to fund a lot of their long term investment portfolios. The fact that the basis on the G7 simple average is moving lower, and is much lower than it was in 2018 is telling. In 2018 the basis was still negative on the swap so it did imply some sort of dollar shortage, and bank credit risk being added to that premium. However, it is nothing like it is now, and we are moving towards averages we did not see since the beginning of the pandemic. This leads me to the conclusion that this is much worse than it was last hiking cycle. As you mentioned weaker economies with lower forex spot rates is going to cause a lot of pain for many of these countries.
Thanks for the great explanation!