- Powell testifies again today after his first day is received as mildly hawkish
- Treasury’s refunding operation continues with 10-year T-note auction
Powell testifies again today after his first day is received as mildly hawkish — Fed Chair Powell today will appear before the Senate Banking Committee in the second and final day of his 2-day presentation of the Fed’s semi-annual report to Congress on monetary policy. Mr. Powell will deliver the same prepared text, but there could be some fresh news today as he answers different questions.
Mr. Powell on Tuesday, speaking before the House Banking Committee, reaffirmed the strength of the economy and indicated that Fed policy remains firmly on hold. The markets reacted to his testimony in a mildly hawkish manner. The federal funds rate curve on Tuesday turned more hawkish by about 4 bp for the contracts from the middle of this year through 2021.
The market is now discounting only a 9% chance of an FOMC rate cut at the next meeting on March 17-18 and a 25% chance of a rate cut at the following meeting on April 28-29. The market is not fully discounting a -25 bp rate cut until the Sep 15-16 meeting. The market is discounting a total of 37.5 bp of easing by the end of this year (i.e., 1.5 rate cuts), less than 41 bp on Monday.
Mr. Powell said the coronavirus presents a downside risk that the Fed will be watching, but that the virus doesn’t change the Fed’s view that monetary policy is currently at the appropriate level. He said, “we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy.” He added, “We know that there will be some, very likely be some effects on the United States,” and the question for the Fed will be whether the impact is “persistent” and “material.” He added, “It’s just too early to say.”
Regarding trade, he said, “Some of the uncertainties around trade have diminished recently, but risks to the outlook remain.” He said the Fed still has a solid outlook for the economy and that, “There’s nothing about this expansion that is unstable or unsustainable.”
Mr. Powell said the Fed would release the results of its comprehensive review of monetary policy “likely around the middle of the year.” The Fed in that review could make some slight adjustments regarding its 2% inflation target and about its long-term plan for managing reserves and monetary policy.
Regarding the Fed’s T-bill purchase program, Mr. Powell said that the Fed has a preference to move away from its current reliance on repos for providing sufficient reserves to the banking system. The Fed last October began its program of buying $60 billion per month of T-bills in order to boost its balance sheet and permanently inject reserves into the banking system to match bank demand. Mr. Powell said that the appropriate level of reserves should be reached by mid-year, which is in line with market expectations that the Fed will likely end its T-bill purchase program by about June, with a possible tapering in the prior 2-3 months.
The Fed has so far boosted its balance sheet via its T-bill purchases by $407 billion from the 6-year low in August 2019, thus reversing 54% of the overall balance sheet drawdown seen during 2015-19. If the Fed continues its T-bill program through June (i.e., 5 more months at $60 billion per month), then the balance sheet should rise by about another $300 billion, resulting in an overall rise of about $700 billion.
That would mean that the T-bill purchase program by the time it ends will have reversed about 90% of the 2015/19 drawdown and put the Fed’s balance sheet only about $50 billion below the record high of $4.52 trillion posted in Jan 2015. The Fed is essentially admitting that it woefully underestimated the banking system’s need for reserves and never should have drawn down its balance sheet in the first place.
The stock market is likely to show some caution when the Fed ends its T-bill purchase program since the stock market will no longer have the headwind of $60 billion of reserves being permanently injected into the banking system every month. It does not seem to be a coincidence that the S&P 500 index started its current +12.6% rally a week after the Fed started its T-bill purchase program on October 1, 2019.
Treasury’s refunding operation continues with 10-year T-note auction — The Treasury today will sell $27 billion of new 10-year T-notes. The Treasury will then conclude this week’s $84 billion refunding operation by selling $19 billion of new 30-year T-bonds on Thursday. The sizes of this week’s refunding auctions are unchanged from the last five refunding operations.
The 10-year T-note yield dropped with the rest of the Treasury curve during January due to the global economic damage being done by the Chinese coronavirus. The 10-year T-note yield on January 31 fell to a 5-1/4 month low of 1.502% but has since rebounded mildly higher by 10 bp to the current level of 1.60%.
The 12-auction averages for the 10-year are as follows: 2.42 bid cover ratio, $13 million of non-competitive bids, 4.6 bp tail to the median yield, 37.5 bp tail to the low yield, and 61% taken at the high yield. The 10-year is a little above average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 60.8% of the last twelve 10-year T-note auctions, mildly above the median of 60.1% for all recent Treasury coupons.
