FX MONETARY POLICIES
BS normalisation will be less re- investment, which would increase the stock of US Treasuries and Mortgage-backed securities held in the market while decreasing some of
the excess reserves. Another
impact of less reinvestment will be upward pressure on term premium and mortgage spreads which were largely reduced due to the QE programs, this, in turn, will make the yield curve
steeper;
by Fed’s Fischer own assessment p ot e n t ia l increase 10-year
in term-
premium could be around 100 basis point.
Of course,
the Fed BS normalisation doesn’t
work
in isolation. Hence, we also need to keep in mind how other major players are going to impact the financial markets over the coming months and years. The ECB is one such player and in our view, it will start tapering asset purchases from January, an intention that it will make aware at the October meeting. We also think the ECB’s QE will end by the end of Q2 2018 based on a 10bn taper per month. Te only major player leſt
54 FX TRADER MAGAZINE October - December 2017
a steeper yield curve which in turn will suppress demand, inflation and employment. This means that Fed plans of three more rate hike in 2018 are more idealistic than practical. Even if growth continues at a steady pace it is unlikely that labour market and inflation will keep pace as steeper yield curve slow business investments further. Also, there are other factors that could derail global growth such as slowing Chinese growth
buying assets by H2 2018 will be BoJ and hence, any change of plan at the BoJ will further derail any meaningful plan of BS reduction.
If all goes to plan the above scenario is likely to cause a sharp jump in term premium globally, this will lead to
(S&P global ratings recently
downgraded China’s Sovereign credit ratings), a further rise in tensions with North Korea, a sharp drop in global equities and a heightened volatility.
Fed plans of three more rate hike in 2018 are more idealistic than practical
In our view, the Fed plan to reduce BS is very likely to run into obstacles if not late 2017/ early 2018 (especially if data derails and market panics) then mid to late 2018 as the impact of a reduced dose of QE starts to take effect. Even from a very optimistic point of view Fed raising rates three
times
next year and c oncur r ent ly reducing
BS
at the scale proposed is likely to put the screws on the economy. Balancing this act at this scale has never been taken in the history of mankind hence; when the Fed Chair Yellen says that unwinding the QE will be akin to watching the paint dry, we don’t quite buy it.
Rahul Khanna
Chief FX Strategist TraderMade
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