While Powell's remarks were generally in line with expectations, accentuating the slack in the labor market as a reason why the Fed will not be hiking any time soon, if ever, while observing the stabilization in the US and global economy and confirming monetary policy is on "autopilot", so to speak, into 2021 while being flexible to respond to downside risks (i.e., it will cut rates as soon as markets drop), what traders were most interested in were Powell's comments on the repo market in the aftermath of the Zoltan Poszar repo "doomsday" blockbuster. In fact, there was a question in the Q&A in which a reporter specifically asked what if anything the Fed is thinking about the suggestion that the shortage of reserves could spark a QE4 in the next few days.
Not surprisingly, Powell was subdued - as the alternative would be to spark even more concerns that the Fed is worried about repo - and said that repo operations have “gone well so far” and “pressures in money-markets in recent weeks have been subdued.”
The Fed chair surprised markets saying that the Fed is also open to Coupon purchases, although for now it is more focused on the bill purchases as the current regime of bill purchases is going well and according to expectations.
“We’re not at this place, but if it does become appropriate for us to purchase other short-term coupon securities, then we would be prepared to do that if the need arises,” he said at his post-decision news conference Wednesday. The Fed is “willing to adapt” its strategy on bill purchases.
Whereas bill offerings were at least four to five times oversubscribed a month-and-a-half ago, the subscription levels have continued to drop, “which would be indicative of growing resistance to sell those bills,” Credit Suisse's rates strategist Jonathan Cohn said. "That would serve as a source of motivation to more seriously consider Fed purchases of short-term coupon securities."
As an aside, Powell's veiled hint that the Fed may shift to Coupon purchases, effectively transforming NOT QE into QE 4 is what sparked a buying spree across the curve, also sending the dollar to session lows.
Powell also said the central bank stands ready to adjust details of its repo operations as appropriate to keep the fed funds rate within the central bank’s target range, adding that as the underlying level of reserves moves up because of bill purchase, there will be a time when it will be appropriate for overnight- and term-repo offerings “to gradually decline,” though the timing is uncertain.
That said, he noted cryptically that the "purpose is not to eliminate all volatility in the repo market", but that "the purpose is to ensure monetary policy decisions are transmitted to the fed funds rate" which is odd considering it is the Fed's purpose to eliminate all volatility in the equity, bond and FX markets.
Commenting on the Fed Chair's response, Bloomberg rates strategist Ira Powell said “Powell acknowledged that the Fed is open to looking at tweaks to help ease repo funding markets. The Fed is going to keep using current operations until after year end."
What we found more interesting is what Curvature's repo expert, Scott Skyrm said about Powell's commentary on repo, which we present below:
Here is what I heard it when Chairman Powell was asked about the "Repo event" and year-end:
- According to the Chairman, the Fed has the tools to accomplish their goals and they will use them. They stand ready to keep fed funds within the target range and they are prepared to adjust operations as appropriate.
- The Chairman stressed that there is a plan is in place and the "repo markets are functioning well." Temporary upward pressure is not unusual and the pressure is manageable.
- Those are all the positive statements at the press conference in reference to year-end and Repo.
- These are a little less positive: Powell stated that the "goal is not to eliminate all volatility from the Repo market." and there will be a "time for overnight and term repo to gradually decline."
In other words, Powell echoed the general market consensus that just because nothing bad has happened to the repo market since September, that things are under control and there is nothing to be concerned about, and certainly no need to intervene proactively. Which means that Pozsar's worst case scenario is effectively greenlighted, one in which the Fed will have to react to turmoil in the market if and when the reserve shortage strikes in the coming days. As for whether the Credit Suisse strategist is correct, earlier we laid out the two key things to watch into year end to see if the doomsday prediction is coming true.
So who will be right: Powell or Poszar? The answer will be revealed in the coming days.