Everybody seems to believe the Fed is essentially running QE4, while no one dares to be short risk in to the potential signing of a Phase-1 deal. The next monthly purchase pace update is out on Thursday, which could prove to be an eye-opener.
Almost everybody seems to believe that what the Fed is currently doing is identical to a large and substantial QE program, with many market participants extrapolating the initial purchase pace of 60bn/month to last at least until April, possibly even until the end of June 2020. This - ceteris paribus - implies a cumulative growth of bank reserves (or excess liquidity, if you will) of 390bn-510bn (this is wrong in our view, since things can’t be held equal…). Anyhow, everybody probably knows by now that when the Fed does QE, everything just turns perfect – which is indeed reflective in price-action across global markets over the past month or so.
Chart 1: Fed QE usually makes everything alright
However, when the Fed announced its intention to buy bills T-back in October, it started with “with the period from mid-October to mid-November”. Now, a month has almost passed, and a new schedule for the Fed’s POMOs will be released on Thursday November 14: “the Desk [NY Fed] will announce the planned purchase amount and release a tentative schedule of operations for the monthly period”.
Table 2: New POMO schedule due next week – so far there is no pattern for the dollar
It may be too early to expect it already for the 14th, but it’s not completely unthinkable that the Fed will cut its planned purchase pace at some point. For instance, the US Treasury will add plenty of liquidity to the system over the next month, the Effective Fed Funds Rate has dropped towards the IOER rate (meaning easing money market strains), while interest in the Fed’s TOMOs has been range-bound. If the Fed does cut its bill purchase pace, then the extrapolators will need to reassess their calculations, threatening the QE narrative.
Chart 2: USD liquidity momentum will be turning against the greenback
USD liquidity momentum empirically has led the way for the DXY in recent years but has done so with a two to three-month lead. So even if the liquidity momentum has started to turn against the USD, it should be too early to bet on that undermining the greenback yet. What’s more, this time the Fed has basically decided that liquidity will stop shrinking, while in QE1, QE2 and QE3 it decided to sustainably boost liquidity.
How many days in a row can the market reprice optimistically on positive trade remarks? That’s a question to ponder when looking back on the past few weeks. With Trump’s China advisor saying recent good news “may represent wishful thinking on the Chinese side”, Reuters reporting on “fierce internal opposition” and Trump not on board, it may be that the market will be in for a disappointment at some point. That said, Trump may not want to rock the boat during the Christmas shopping season and Black Friday isn’t due until November 29, maybe the market can remain upbeat for a while yet. The hopetimism on trade wrongfooted our AUD/NZD short (stopped out @ 1.0835)
We wouldn’t rule out that an actual signing of a Phase-1 deal could prove to be a yuuge buy the rumour, sell the fact type of event. Currently it is our impression that no one (not even HFs) dares to be short risk before the Phase-1 hype fades.
Geopolitically we remain in the pessimistic camp.