US: What To Watch At The March Fed Meeting

June FOMC meeting is when the real action starts

While economic risks do remain, they are fading with increasing confidence that the economy can reopen fully by the summer. Given the Fed’s current caution, this is more likely to result in a meaningful change in the Fed’s stance at the June FOMC meeting, when the bank next releases forecasts. At that point, we believe they will indicate a slow and steady tapering of asset purchases before the end of the year, possibly involving a twist to focus more of the remaining purchases towards the longer end of the curve. We also expect the majority of FOMC member to predict a 2023 rate hike with possibly a quarter opting for 2022.

This would certainly add to upside pressure on Treasury yields, but the economy will be in a much stronger position to weather it.

Treasury market - getting technical

With the broad brush of Fed policy in a holding pattern, the Fed might just get a bit more technical than usual. Two key items here.

First, they may well have something to say on the emergency adjustment made to the supplementary leverage ratio when Covid broke about a year ago. Back then, the Fed decided to allow US banks to exclude holdings of Treasuries and deposits at the Fed from it, but for a temporary period that is due to end on 31 March 2021. See more on that here. We think they will extend it, and if so, there is nothing to see here. But, if the Fed were to choose not to extend, then there could be repercussions. One could be selling of US bank holdings of Treasuries; we calculate that they currently hold an excess of some $600bn. Another could be that banks choose to take fewer deposits. We think this is less likely, despite the talk, but the Fed could choose to avert this discussion by just extending for deposits, and not for Treasuries. To be seen.

Second, the Fed will be aware that the Secured Overnight Financing Rate (SOFR) has been peppering the 1bp to 2bp area in recent weeks. The SOFR rate is not a Fed policy rate, but still, if it were to hit zero, or worse, dip negative, it would be a tad inconvenient. It could suggest that the Fed has lost some control over the front end, as a key rate hits zero while the economy kicks through the gears. See more on that here. But also, SOFR is an important rate to say the least, as it is the favored rate for use on transition from Libor. In fact, there is official sector pressure in place on players to make that switch sooner rather than later. If SOFR were to go negative, even if briefly, it could cause some to pause for thought. What to do? Provision of more collateral through issuance is one solution. Another is to hike the rate on excess reserves (IOER), just to act as a pull upward on other liquidity buckets.

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