The positive US payrolls report has sent December rate hike odds up to around 80% and along with the 'all clear' from Hilsy, one would expect relative 'strong dollar' flows front-running the divergent policy directions about to be undertaken by The Fed. However, EURUSD continues to rise this morning... here's why...
Given today's 'solid' payrolls print, and the dovishly-hawkish chatter from each and every Fed speaker from Yellen down, it seems clear (and the market was priced for) a December rate-hike is a done deal.
As we detailed last night, [4]a 25bps Fed rate-hike means a liquidity drain of up to around $800 billion... as repo market expert, Wedbush's E.D. Skyrm explains:
Where will General Collateral trade when the fed funds target range is moved 25 basis points higher to .25% to .50%? In the most simple method, GC has averaged about .15% for the past month, which implies a GC rate around .40% after the Fed move.
[5]
However, given the unprecedented amount of liquidity in the financial system, there's a belief the Fed will have problems moving overnight rates higher.
We have two quantifiable events over the past few years where the Fed moved Repo rates higher or lower: quarter-end and the QE programs. Given there are so many moving parts, consider these to be very rough estimates: Beginning in 2015, when funding pressure began each quarter-end, the market, on average, took approximately $255B additional collateral from the Fed and, on average, GC rates averaged 20.5 basis points higher.
In 2013 on my website, I calculated that QE2 moved Repo rates, on average, 2.7 basis points for every $100B in QE. So, one very rough estimate moved GC 8 basis points and the other 2.7 basis points per hundred billion. In order to move GC 25 basis points higher, in a very rough estimate, the Fed needs to drain between $310B and $800B in liquidity.
Putting that in context, QE2 - which pushed the S&P higher from November 2010 until June 2011 - was "only" $600 billion.
If readers didn't just have an "oops" moment, please reread the last bolded sentence until they do, because it explains precisely what the market is missing about the Fed's rate hike cycle: according to Skyrm's calculations, to push rates by a paltry 25 bps, the smallest possible increment, what the Fed will have to do is drain up to a whopping $800 billion in liquidity!
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All of which was supposed to be offset by an 'easy' ECB, ramping up Q€ and 'stabilizing' the market - avoiding the devastating consequences of a major net liquidity drain.
But Draghi did not! With only modest longer-term extensions, reinvestment, and muni expansion. [6]
And so this happened... thus the markets largest transmission mechanism for central bank 'efforts' retraced the entire drop in EURUSD since October Payrolls confirmed the likelihood of a December rate-hike...
[7]
Simply put, Draghi blew it.
And now either The Fed folds on a rate hike... or Draghi has to over-promise once again that "whatever it takes" will mean even more next month and the market misunderstood (and fight the hawks that are building on his committee)... or else the ker-plunk of a $800 billion collapse in collateral chains will ripple excessively through every asset class in the world unwinding consensus carry trades wherever it can.
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And Sure Enough!!!
A day after Draghi did not unleash "more action", he now says more action is required
— zerohedge (@zerohedge) December 4, 2015 [8]
DRAGHI: CHANGES TO QE PROGRAM ADD EU680B IN LIQUIDITY BY 2019. Which is precisely how much liquidity the Fed's 25 bps hike will remove
— zerohedge (@zerohedge) December 4, 2015 [9]
His speech today puts the market straight...
To help you appreciate the import of the overall recalibration of our asset purchase programme, you should consider that the extension of our net purchases to at least March 2017 and the decision to re-invest the principal payments on maturing securities for as long as necessary will add EUR 680 billion – some 6.5% of the euro area GDP – in liquidity to the system by 2019, relative to the situation that would have prevailed under previous policies.
...
But similar to the times when we steered policy primarily through interest rates, we are continuously monitoring economic and financing conditions, on which our policy action is always conditional. If these developments change in directions that make it necessary to respond again, we are of course ready at any time to adjust this array of tools to secure the return of inflation to our objective without undue delay.
as Draghi tries to undo yesterday's error which sent the EUR soaring... but is it too late? And note that the €680 billion in calculated liquidity injection is precisely enough to offset the roughly $800 billion in liquidity that the Fed's 25 bps hike is expected to drain.
[10]
But stocks love his bullshit...
[11]
Full speech here [12]
