E Fed Meeting, Nonfarm Payrolls, Tech Earnings Highlight Critical Week For S&P 500

The previous trading week commenced with a degree of frenzied selling pressure on Tuesday and within the context of slowing global growth and geopolitical uncertainty. Highlighting fears of a slowing global economy was the IMF downgrading its global growth outlook. With a failed Brexit vote and a U.S. government shutdown inside its 4th week, investors took shelter in bonds and gold, but that changed very quickly as liquidity remained supportive to equity markets.

Revisiting QE & Liquidity

As I mentioned in the past, central banks remain accommodative and the money supply into the global markets is adding liquidity to the financial system. This produces a risk-on environment, assuming all things equal that include the global economy. We witnessed examples of accommodative policy and activity centered on liquidity and increasing the money supply virtually all week from the People’s Bank of China (PBOC).

Based on the Tuesday selloff, it seemed as though the rally since January 2, 2019 was in jeopardy. That retracement, however, quickly turned higher the very next day and with the direct injection of liquidity from the PBOC.

After this PBOC action, markets rebounded the very next day and the S&P 500 also rallied through Thursday. And what happened Thursday overnight? You guessed it, yet another round of easing and liquidity from the PBOC. Just like QE in the U.S., where financial system liquidity was boosted by the Fed injecting reserves into banks in exchange for sales of Treasurys and MBS, the PBOC announced that it will allow China's primary dealers to swap their holdings of perpetual bonds for central bank bills, and directly use those bonds as collateral to access certain PBOC liquidity operations.

Rabobank's Michael Every writes "Chinese banks, desperate for cash to keep the Ponzi scheme afloat, can issue perpetuals that nobody in their right mind would want to hold; and the PBOC will swap them for its bills." If you think what China is doing is normal, it isn’t, but neither was the U.S. TARP program and it’s QE program, which lasted for nearly 8 years. What we’re trying to suggest with this comparison is that something or many things are very, very wrong with the Chinese economy. Regardless of what we may think about the PBOC’s policies and activities, the markets like increased liquidity and money supply. The chart below identifies how much the global money supply has increased since it bottomed in November 2018.

When we combine the extreme PBOC policy stance with that of the Federal Open Market Committee (FOMC) here in the United States, we can better understand the newfound appetite for risky assets. The FOMC/Fed has quickly changed its more hawkish stance on monetary policy, which found the central bank raising rates 4 times in 2018, to that which is more accommodative and believed to halt rate hikes until its forecast for the economy improves alongside an increase in inflation.

With the latest round of liquidity injections from the PBOC and the European Central Bank concluding its meeting that also indicates rate hikes are unlikely until at least the summer of 2019, the FOMC will hold its 2-day meeting this coming week. Officials are expected to keep interest rates unchanged, but investors see scope for the Fed’s statement to tilt dovish, or for Powell to signal as much in his comments, a shift that could help drive yields lower. Also in focus, any hint that the central bank is closer to ending its balance-sheet runoff, which, combined with the deal to reopen the government, could bolster risk sentiment in favor of equities. 

Probably the most important and still debated FOMC activity centers on the Fed’s balance sheet. Will, they or won’t they continue to unwind/sell the assets they hold on the balance sheet, nearly $4trn in Treasurys? Many economists and analysts have likened the balance sheet unwinding activities to that of raising rates and tightening fiscal monetary conditions. The Fed generally schedules these asset sales on the 15th, 20th and 25th of every month.

According to the Wall Street Journal, this very subject has also been front of mind with Fed officials and possibly will bring about the end of quantitative tightening.

Federal Reserve officials are close to deciding they will maintain a larger portfolio of Treasury securities than they’d expected when they began shrinking those holdings two years ago, putting an end to the central bank’s portfolio wind-down closer into sight.  

Officials are still resolving details of their strategy and how to communicate it to the public, according to their recent public comments and interviews.

Fed officials led markets to expect the process would take several years to play out. When the runoff began in October 2017, various officials estimated the portfolio—then around $4.5 trillion—could shrink to anywhere between $1.5 trillion and $3 trillion. New York Fed President John Williams said in April 2017, when he was the San Francisco Fed’s president, that runoff could last five years.

“In about three or four years, we’ll be down to a new normal,” said Fed Chairman Jerome Powell at his Senate confirmation hearing in Nov. 2017."

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