To The Moon

Views are my own. Just my thoughts on macro developments. Not investment advice.

Policy makers have an extremely difficult balancing act to perform. The two sides of their mandate, Price Stability and Financial Stability, each call for different actions. They cannot abandon either so instead they must walk the tightrope between the two. Showing the market they are just as serious about both otherwise they risk falling along with their respective economies. So far ECB’s Lagarde has set the standard on how this should be done. Hiking 50bps and committing to continuing to fight inflation whilst pointing to other tools to support Financial Stability. Lagarde: “I have made clear that there is no trade-off between price stability and financial stability,”. “We have plenty of tools to provide liquidity support to the financial system if needed and to preserve the smooth transmission of monetary policy.”

Arguably the BOE was actually the first to implement this kind of strategy during the UK Pension Fund LDI crisis last year. Despite the huge financial instability the BOE stuck to its course of hiking rates to tackle inflation but simultaneously intervened to backstop liquidity in the market. We have already seen these kinds of moves from Central Banks as a result of the SVB turmoil. The Fed has introduced the BTFP (Bank Term Funding Program), not to be confused with BTFD… This program makes treasury holdings at US banks the equivalent of cash as they can be put on repo with the Fed at par value. This along with beefed up USD swap lines that can now be accessed daily should stem any liquidity issues for now. The easing of liquidity concerns is what is allowing risk assets to rally despite the huge knock to confidence of late. I remain concerned about other fragilities that could be hiding in the system. Bank profitability remains under pressure due to inverted yield curves. Deposit flight also still remains an issue as it is very clear that depositors can get higher yields and more security parking their money in government securities than leaving on deposit at banks. I also wonder what other fragile parts of the system could be next to show stress. Such as Auto Loan CLO’s, MBS, PayDay lending, Credit Card debt ect. The liquidity issues have been stemmed for now but the credit/solvency issues are probably the next shoe to drop.

It remains a difficult and uncertain backdrop to trade. I still like to run a defensive portfolio of long USD, XAU and CHF and short growth currencies. NZD stands out to me as the best short. Q4 GDP for last year has already shown to have been in contraction in New Zealand. Despite this the market is still pricing another 40bps of hike from the RBNZ. The overleveraged and frothy housing markets of New Zealand, Australia and Canada are likely to come under increasing pressure in this environment. NZD tends to underperform in a crisis and has a large current account deficit so I feel it is particularly. vulnerable in this backdrop. The pop higher to 0.6300 this week provided a great selling opportunity and that level is now resistance going forward.

As for the FOMC tonight this is a very tough one to call. I suspect Powell will follow a similar path to Lagarde and stress that they need to stick to their battle against inflation. This probably means a 25bps hikes and possibly a small increase to the terminal rate from the Dot Plot. The last SEP had the terminal rate around 5.125%. Since then US data has been strong and would certainly justify a move up until the recent financial instability.

Just as a reminder of what Powell said last time we heard him speak before the US banking problems. Powell:

“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,”

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

“We will continue to make our decisions meeting by meeting,” Mr. Powell said. “Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy.”

Those comments feel like a lifetime ago and arguably we are in a very different world now. The market had moved to price in 40bps for the March meeting and a terminal rate of close to 5.7%. Now as we go into the meeting the market is pricing 21bps and a terminal rate of 4.95%. With such an uncertain backdrop it will be important to stay nimble. It will be easy for Powell to come across hawkish if he sticks to a similar script as before.

CrossJPY is very difficult to trade here. JPY is not a typical safe haven like XAU and CHF, it depends more on rates than risk aversion. Therefore the hawkish rhetoric out of Lagarde and expectations of Powell to follow a similar line have dragged crossJPY back higher despite the weak growth backdrop. Medium term I expect crossJPY to trend lower as the global economy heads into recession. Although with the uncertainty around inflation still dragging rates higher in the short term it is a difficult trade to time. I was stopped out of a EURJPY short on the push back up through 143.00 this morning so I stand aside in JPY for now and will keep an eye on rate differentials for direction.