Will he or won’t he?
The bond and stock markets are definitely calling Jay Powell’s bluff ahead of his speech as chatter of The Fed “losing control” of the yield curve and the potential disaster of the expiration of SLR exemption have the Fed Chair cornered into, at minimum, hinting at one and/or the other during today’s virtual event hosted by The Wall Street Journal.
Newsquawk provides a quick overview of what to expect:
In remarks last week, Fed officials largely avoided talking about the bond slide, and the implications for the Fed’s reaction function. Many reasoned that financial conditions had not tighten significantly to concern the Fed, and that line of thinking was vindicated as fixed income markets stabilised, as did equities. This week, however, officials have been clamouring to reiterate the tools that the Fed has available at their disposal to manage any inappropriate market behaviours, and accordingly, there are building expectations that the Fed chair will also comment on the theme later today.
Some have suggested that, given Powell will be speaking in a personal capacity, he will be unable to presuppose the outcome of the March FOMC, and therefore, might stick to a familiar script (reiterating that the near-term is mired by uncertainty, the outlook for the second half is brighter, asset purchases at the current rate remains appropriate for this year at least, it will take a great deal of time for inflation to moderately exceed the Fed’s target sustained basis, perhaps three years; there is still a huge amount of progress needed in the labour market).
That being said, there are some areas that could help guide expectations for the March FOMC: It will be interesting to see whether he acknowledges the choppy yield curve action last week; the Chair has already said that raising the size of asset purchases and moving towards buying longer-dated maturities was an option; in this respect, it is important to distinguish between extending weighted average maturities of asset purchases and a potential ‘Operation Twist’; the latter might be a more appropriate technical tool to manage market functioning (if, for instance, the SLR relief banks enjoy was not extended beyond March). On that theme, again, it is a subject for the FOMC to discuss, so Powell will not be able to presuppose the outcome; he recently said no decision had been made (expectations are for it to be extended to prevent market disfunction).
WHAT IS SLR RELIEF: The supplementary leverage ratio requirement, or SLR, a capital rule that requires large banks to hold at least 5% capital of total assets. In April 2020, the Fed exempted Treasuries and reserves from banks SLR, which allowed them to build balance sheets by purchasing Treasuries — this arrangement is set to expire at the end of March, and if it were not extended, banks would have to hold more capital against their holdings of Treasuries, which would likely result in reduced demand for government debt, perhaps triggering in a wave of Treasury selling, which could reduce funding for other Treasury investors, stoke volatility in fixed income markets, and potentially result in significant market disfunction. An SLR extension would also require FDIC and OCC approval too, not just Fed, adding another factor to consider in whether or not it is extended; some analysts suggest that this is why Fed officials may be taking a circumspect approach to questions on the subject, reiterating that no decision has yet been made.
Finally, we note that, in what was potentially a preview of Powell’s remarks, Governor Lael Brainard stressed on Tuesday how far the Fed was from meeting its objectives.
“We have quite a lot of ground to cover,” she told a Council on Foreign Relations webinar. “It’s appropriate to be patient.”
Brainard said that the speed of last week’s moves in the bond market had “caught my eye,” adding that she would be concerned if she saw disorderly trading, or a persistent tightening in financial conditions, that could slow progress toward the Fed’s goals.
So will Powell hint at Twist 3.0 (implicit YCC) and/or SLR exemption? And what will the market do?
Watch live here (due to start at 1205ET):
