[Fed] Waller: Reversed Operation Twist?

Remarks of Officials

Summary:

The Federal Reserve should increase the proportion of shorter-dated Treasury securities in its balance sheet and reduce its holdings of agency mortgage-backed securities (MBS) to zero.

Fed Governor Christopher Waller spoke at the U.S. Monetary Policy Forum on March 1 (EST) on quantitative tightening, with the key points as follows.

Waller expected two results regarding the long-term issues related to the Fed's portfolio:

Firstly, he would like to see agency mortgage-backed securities (MBS) reduced to zero because these assets are less liquid and are reduced more slowly, with the average reduction in MBS being about $15 billion per month. The underlying mortgages have very low interest rates and prepayments are quite small.

Secondly, he would like to increase the proportion of shorter-dated Treasury securities. Before the global financial crisis, about one-third of the Fed's portfolio was shorter-dated Treasuries. Today, the size of shorter-dated Treasuries is less than 5% of the Treasury holdings and less than 3% of the total portfolio size.

On the one hand, increasing the share of shorter-dated Treasuries would allow the Fed to better adjust the maturity structure of assets on its balance sheet to more closely match the overnight federal funds rate. On the other hand, holding more short-term Treasuries would link the Fed's investment income more closely to its interest payments to banks.

In addition, increasing the proportion of shorter-dated Treasuries means that the Fed can more flexibly adjust the size and structure of its balance sheet. By not renewing shorter-dated Treasuries at maturity, the Fed can avoid the need to purchase or hold large amounts of additional long-term assets when providing liquidity support to the market, thus controlling the growth of the total size of its balance sheet.

The balance sheet deduction (Quantitative Tightening, QT) and the decision to determine the U.S. benchmark interest rates are independent of each other. Also, whether or not to increase the share of short-term Treasuries will be a matter for the FOMC to decide over the next few years.

Note: Waller's view to "buy short-term bonds and sell long-term bonds" is similar to the Fed's previous " operation twist", except for the operation of "selling short-term bonds and buying five-year U.S. Treasury bonds" during the 2011-2012 period to reduce the interest rates on long-term bonds. This can reduce the borrowing cost of small and medium-sized enterprises and stimulate the economy. Waller's remarks can be interpreted as a "reversed operation twist".

After Waller's speech, the interest rate-sensitive two-year U.S. bond yields fell further by more than 10 basis points to 4.52%, the lowest level since February 15th. Longer-dated U.S. bond yields fell less, with the 10-year U.S. bond yield falling by 6 basis points to 4.18%. The degree of inversion of the U.S. bond yield curve eased.

We can see the impact of Waller's comments on the bond market.

On the same day, Dallas Fed President Lorie Logan repeated that with bank reserves decreasing, the Fed may begin to slow down its pace of balance sheet shrinking.

Waller and Logan's remarks came at an opportune time, as the Fed's overnight reverse repurchase agreement (RRP), the Fed's liquidity adjustment facility, had $128 billion of liquidity drained in two days. The balance dropped by 22% to $441.265 billion, below $500 billion again since February 15.

Moreover, the Fed's emergency bailout tool, the Bank Term Funding Program (BTFP), was launched during last year's banking crisis. It will expire in March and will not be renewed, and banks will be forced to fund their $160 billion shortfall through the discount window.

All of these suggest that liquidity risks may be concentrated in March, and the Fed will be forced to stand at the crossroads again. At this particular moment, Waller's speech may not be a "coincidence", and it may become one of the Fed's choices, but it also means that the path of balance sheet shrinking may be adjusted greatly.

Waller's Speech

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ING

Economic

Production of semiconductors and automobiles fell, but this is expected to be a temporary pause

Manufacturing and mining industrial production (IP) fell by -1.3% MoM sa in January (vs revised -0.5% in December, 0.9% market consensus) led by declines of semiconductors (-8.6%), machinery (-11.2%) and automobiles (-3.2%). We view this as a temporary pause after the strong production over the past two to three months, as other indicators, such as exports, capacity utilization ratio, and surveys, are still strong. Meanwhile, a new mobile phone model launch has pushed up the output of telecommunication tools (46.8%). Inventory levels edged up 0.4% MoM sa in January, but this is the first rise in five months.

All industry IP rose by 0.4% MoM sa in January

Apart from manufacturing, services (0.1%) and construction (12.4%) activity grew, while public administration fell (0.7%). Software development (4.9%) and real estate services (2.6%) rose while whole/retail sales (-1.0%), leisure (-8.9%), and hotels & restaurants (-0.2%) declined. We believe that service activity related to household spending has deteriorated, so household consumption is likely to weaken, while IT services have recovered along with the upturn in AI chip manufacturing.

On a three-month comparison, all industry IP growth has slowed to 0.4% (3Mo3M) sa in January from 0.7% in December, suggesting that 1Q24GDP will be slower than in the previous quarter. Moreover, a downward revision of December IP (-0.5% vs flash 0.6%) suggests that the revised 4Q23 GDP (to be released tomorrow) may be revised down from the initial estimate of 0.6% QoQ sa.

Retail sales rose for a second month as Chinese tourists returned

Retail sales rose 0.8% MoM sa in January but the details were mixed. Durable goods fell for a second month. Most notably, automobile sales plunged -16.24% as the government's tax incentive programme expired in December. Meanwhile, the launch of new mobile phone models boosted sales of telecommunications equipment and computers (28.2%). Semi-durable goods also declined -1.4%. Non-durable goods rose 2.3% with Chinese tourists' spending on cosmetics increasing meaningfully. We believe domestic consumption weakened in January excluding the Chinese tourist impact.

Facility investment dropped while construction rebounded

Equipment investment dropped 5.6% MoM sa in January as chip-making equipment imports declined. Forward-looking machinery orders also fell for a second month giving a cloudy investment outlook in the near-future. Construction completions jumped 12.5%, both for major residential construction and civil engineering projects completed in January. Hiwever, construction orders dropped again, suggesting sluggish construction activity will continue for a considerable time.

In addition, manufacturing PMI points a moderation of GDP in current quarter

Not only did manufacturing activity growth slow, but retail sales of residents and investment activity also softened. In a separate report, the manufacturing PMI edged down to 50.7 in February from 51.2 in January, suggesting a potential slowdown in manufacturing as well. However, the PMI remained above the neutral level for a second month, thus indicating continued growth. Today's dataset supports our view that 1Q24 GDP will decelerate modestly to 0.5% QoQ sa with growing downside risks to the current forecast.

To stay updated on all economic events of today, please check out our Economic calendar

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Kevin Du

Economic

Commodity

In stark contrast to the ongoing weakness in China's key manufacturing index, the imports of key commodities by the world's second-biggest economy are roaring ahead.

China's imports of crude oil, liquefied natural gas (LNG), coal and iron ore were all stronger in the first two months of 2024 than for the same period last year, according to data from commodity analysts Kpler and LSEG Oil Research.

Yet, though robust commodity imports appear at first glance to be out of alignment with soft property construction and manufacturing data, they can be reconciled when market dynamics such as stockpiling and price moves are taken into account.

Crude oil imports were 11.73 million barrels per day (bpd) in February, up from 11.31 million bpd in January, according to LSEG data.

Over the first two months of the year, LSEG estimates China's oil arrivals at 11.51 million bpd, which is 1.07 million bpd higher than the 10.44 million bpd official customs figure from January and February last year.

China combines import data for January and February into a single release to mitigate the impact of the Lunar New Year holidays, and the official customs numbers for the first two months of 2024 are expected on March 7.

China's imports of LNG were 5.7 million metric tons in February, down from January's 7.82 million, according to Kpler.

However, the combined 13.52 million tons for the first two months of this year was 22.5% above the 11.04 million tons for the same period last year.

Imports of iron ore were estimated by Kpler at 101.5 million tons in February, down from 113.0 million in January, which was the second-highest in Kpler data going back to 2017.

The combined 215.5 million tons for the January-February period was 4.6% higher than the 206.1 million tons for the same months in 2023.

Imports of all grades of coal were also robust in the first two months of this year, with Kpler estimating seaborne arrivals of 28.4 million tons in February and 34.0 million in January, for a total of 62.4 million.

This was 28.1% higher than the 48.7 million tons of seaborne arrivals in the first two months of 2023.

The strength in imports of major commodities appears to be at odds with the ongoing run of soft outcomes in China's official Purchasing Managers' Index (PMI).

The PMI shrank for a fifth month in February, coming in at 49.1 points, down from 49.2 in January, and staying below the 50-level that separates growth from contraction.

While some of the weakness may have been caused by factories closing for the week-long Lunar New Year holidays, the PMI data indicates that China's economy is at best spluttering along.

This makes it more likely that further stimulus measures are likely to be adopted, with the focus on this week's meeting of parliament.

Whether any new initiatives will be enough to rouse China's economy remains to be seen, but the recent track record of modest steps suggest something bolder than what is likely to eventuate will be needed.

Strong commodities, weak economy?

The question is whether China's strong commodity imports can be reconciled with the evident weakness seen in key sectors of the economy, such as residential housing construction and manufacturing.

Each commodity has its own market dynamics and the robust crude imports can be viewed through the prism of lower oil prices when cargoes would have been arranged, and the early release of import quotas for most refiners.

Global benchmark Brent crude futures were in a downtrend from October to mid-December, reaching a low of $72.29 a barrel on Dec. 13.

The lower prices, coupled with the 60% increase in the first tranche of import quotas, would have encouraged refiners to buy more than they intended to process, thereby boosting inventories as a hedge against possible higher prices later this year.

Coal imports have been strong because of high electricity demand and lower than usual hydropower output.

A further factor has been some constraints on domestic mine output because of safety checks, which has also kept domestic prices elevated, meaning imports can compete on a price basis.

China's top coal supplier is Indonesia, and the price of Indonesian coal with an energy content of 4,200 kilocalories per kilogram, as assessed by commodity price reporting agency Argus, has been relatively stable in recent weeks, hovering near two-year lows and ending at $58.01 a ton in the week to March 1.

Iron ore is perhaps the commodity most difficult to fathom, as strong imports don't necessarily align with weakness in the property sector.

However, steel mills and traders have been building up inventories in recent weeks, possibly in anticipation of more stimulus measures, with consultants SteelHome reporting port stockpiles rising to 134.9 million tons in the week to March 1., up 28.6% from the seven-year low of 104.9 million in the week to Oct. 23.

Overall, the strength in China's commodity imports can be aligned with weakness in other sectors of the economy, and show that the economic story is more nuanced than the simple narrative of sluggish growth.

Source: Yahoo

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FastBull Featured

Remarks of Officials

The Federal Reserve submitted its semi-annual monetary policy report to Congress on March 1, with the key points as follows.

Inflation has eased substantially over the past year but remains above the target level, and the slowing in inflation has occurred without a significant increase in unemployment. The labor market remains relatively tight, with the unemployment rate near historically low levels and job vacancies still elevated. Real gross domestic product growth has also been strong, supported by solid increases in consumer spending.

Demand for labor has eased as job openings have declined in many sectors, but labor demand still exceeds supply. Labor supply has trended higher over the past year, reflecting a continued strong pace of immigration and increases in the labor force participation rate, particularly among prime-age workers.

Acute stress in the banking system has receded since last spring. Risk-based bank capital ratios stayed solid and increased broadly as bank profits were robust and banks reduced capital distributions. Overall, the banking system remains sound and resilient, but a few areas of risk warrant continued monitoring.

The Committee views the policy rate as likely at its peak. In considering any adjustment to interest rates, the Committee will carefully assess the data, the changing outlook, and the balance of risks. The Committee does not expect it will be appropriate to cut interest rates until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

Fed Chairman Jerome Powell will testify before Congress on Wednesday and Thursday after the Fed submitted its semi-annual monetary report to Congress. The report is typically a review of economic developments and actions taken by the Fed since the last update to lawmakers, but it will also offer new views of some latest economic data and topics such as financial stability.

Powell is likely to face a barrage of lawmaker questions about the Fed's tight policy stance and expectations for easing it, a sensitive topic in a presidential election year.

Some congressional Democrats have already taken Powell to task over high interest rates, complaining they are exacerbating already-poor housing affordability for low- and middle-income households. Republicans, meanwhile, have been critical about the Fed's initially slow response to inflation and could chastise Powell over indications he may lower rates ahead of the November election.

The Fed's Monetary Policy Report

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Economic

Stocks

Markets overlook Core PCE rise

U.S. equity markets finished last week on a high note, locking in a sixteenth week of gains out of eighteen for the first time since 1971.

The gains came despite a robust Core PCE print, with markets as expected choosing to look through the number. This perspective was partly based on the view that the rise was driven by one-off New Year price increases in the services sector (including medical and financial services).

Fed rate cut expectations adjust

Additionally, in the lead-up to last week's core PCE release, expectations of Fed rate cuts in 2024 had repriced significantly lower. After starting the year with almost seven 25 bps Fed rate cuts, the rates market finished last week with 81 bps of rate cuts priced for 2024, in line with the Fed's projections of three rate cuts.

Upcoming economic insights

This week will provide further insights into the state of the economy and the timing of potential rate cuts with speeches by several Fed members, including Fed Chair Powell's Semi-annual Monetary Policy Testimony to Congress, as well as labour market updates that include the ADP employment report, JOLTS Job Openings, and Non-Farm Payrolls.

Non-Farm payrolls

Date: Saturday, 9 March at 12:30am AEDT

Recent job market strength

In January, the U.S. economy added 353k jobs, exceeding market expectations of a 180k gain, with the unemployment rate holding steady at 3.7%. This stronger-than-expected number in January followed a very strong 333k increase in December and provided a further reminder that the U.S. labour market remains tight.

February's employment outlook

For February, the U.S. economy is expected to add 195k jobs with the unemployment rate projected to remain at 3.7%. The participation rate is expected to rise marginally to 62.6% from 62.5% previously. Average hourly earnings are forecasted to increase by 4.3% YoY in February, easing from 4.5% in January. Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_1

Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_1

S&P 500 technical analysis

Following a brief consolidation period in mid-February ahead of Nvidia's earnings report, the uptrend in the S&P 500 resumed, with the index closing last week at fresh record highs, 25% above its October low.

As long as the S&P 500 cash level remains above the uptrend and horizontal support at approximately 5060/50, the market's direction is likely upwards.

However, a consistent loss of support around 5060/50 would indicate that a more significant correction is on the horizon, initially towards 4900. Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_2

Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_2

Nasdaq technical analysis

Similar to the S&P 500, the Nasdaq saw a brief consolidation period in mid-February before regaining momentum, finishing last week at new record highs, 30% above its October lows.

Provided the Nasdaq cash level stays above initial support at 18,000 and does not fall below a range of horizontal support at approximately 17,300/100, the likelihood is for continued upward movement.

Should the Nasdaq breach support at around 17,300/100 on a sU.S.tained basis, it could signal the start of a deeper pullback towards 16,200. Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_3

Wall Street Hits New Highs Amid Powel's Testimony and Positive Job Data_3

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Owen Li

Commodity

U.S. production of oil and gas set new seasonal records in December, capping off an unprecedented year, according to data published by the U.S. Energy Information Administration (EIA) on Thursday.

Production continued to climb even as prices slumped from the very high levels seen in mid-2022 after Russia’s invasion of Ukraine, contributing to the accumulation of inventories.

On the oil side, total production of crude and condensates increased to 413 million barrels in December from 376 million in the final month of 2022 (“Petroleum supply monthly”, EIA, Feb. 29, 2024).

Production was running at 13.3 million barrels per day (b/d) in December, an increase of 1.2 million b/d (10%) from a year earlier.

The prior-year comparison was flattered by the extreme cold which caused widespread well freeze offs and a brief but sharp drop in production in late December 2022.

For the year as a whole, however, output increased to 4,721 million barrels in 2023, up from 4,347 million in 2022, and had doubled since 2012.

Inflation-adjusted front-month U.S. crude futures averaged $72 per barrel (44th percentile for all months since 2000) in December, down from a recent high of $121 (82nd percentile) in June 2022.

Oil-directed drilling has slowed in line with the fall in prices, with a delay of around five months, which is typical given the time taken for part-drilled wells to be completed and rig hire contracts to expire.

The number of rigs drilling for oil averaged 501 in December, down from 623 in December 2022, according to oilfield services company Baker Hughes.

But there was no comparable downturn in output as rigs boosted efficiency by concentrating on only the most promising sites and crews streamlined the drilling process.

Horizontal well sections became even longer, maximising contact with the reservoir and allowing more oil to be recovered from each well.

In the short term, the U.S. oil industry has become adept at producing more oil, at lower prices, with fewer drilling crews.

In the medium term, it is unclear if the industry can continue raising efficiency at the same rate or whether further output growth will depend on higher prices.

If production is already starting to flatten out in response to lower prices, the evidence remains inconclusive so far.

U.S. Gas Production

Dry gas production climbed to a seasonal record of 3,300 billion cubic feet (bcf) in December from 3,107 bcf a year earlier (“Natural gas monthly”, EIA, Feb. 29, 2024).

For the year as a whole, production hit a record 37,883 bcf, up from 36,353 bcf in 2022, and had doubled since 2006.

Inflation-adjusted futures prices slumped to $2.55 per million British thermal units (4th percentile for all months since the start of the century) in December.

Prices have since fallen to an average of just $1.80 last month, the lowest in real terms since at least 1990, when the futures contract started trading.

As with oil, the number of rigs has fallen, but there has been no decline in production, leaving the market persistently oversupplied.

The number of rigs drilling for gas averaged 119 in December, down from an average of 162 in September 2022, the recent peak.

But production has continued to climb for the same reasons as oil – concentration on the most promising sites, streamlined work practices and longer well laterals.

Output has also continued to rise because lots of gas is recovered as a co-product from new and ageing oil wells.

Production has risen much faster than domestic and export demand, causing a huge accumulation of inventories and intensifying the downward pressure on prices.

Working gas stocks in underground storage were 461 bcf (+24% or +1.25 standard deviations) above the long-term average on Feb. 23.

The surplus has swelled from 64 bcf (2% or +0.24 standard deviations) at the start of the heating season on Oct. 1.

Strong El Nino conditions in the Pacific have resulted in a much warmer than average winter across the northern United States, cutting gas consumption.

But persistent over-production and the delayed response to falling prices has turned a warm winter into a prodigious glut of gas.

Source: Devdiscourse

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Devin

Commodity

Saudi Arabia, the world's biggest oil exporter and OPEC's largest producer, extended its voluntary output reductions until the end of the second quarter of 2024 in order to support oil market stability.

The kingdom will extend its voluntary cut of "one million barrels per day, which was implemented in July 2023, until the end of the second quarter of 2024 in co-ordination with some OPEC+ participating countries", the state-run Saudi Press Agency said on Sunday, quoting an official source from the kingdom's Ministry of Energy.

The production cut is in addition to the voluntary cut of 500,000 barrels a day previously announced by the kingdom in April 2023, which will stay in effect until the end of December 2024, SPA said.

The kingdom's production will be approximately 9 million bpd until the end of June 2024. "Afterwards, in order to support market stability, these additional cut volumes will be returned gradually subject to market conditions," the official said.

Saudi Arabia said this "additional voluntary cut comes to reinforce the precautionary efforts made by OPEC+ countries with the aim of supporting the stability and balance of oil markets".

Last month, OPEC+ members announced they would keep their oil production policy unchanged.

"The JMMC reviewed the crude oil production data for the months of November and December 2023 and noted the high conformity for participating OPEC and non-OPEC countries," OPEC said in a statement at the time.

In their previous meeting, in November, OPEC+ members including Russia and Saudi Arabia extended their voluntary oil output reductions until the end of the first quarter of 2024 due to concerns about fuel demand. Saudi Arabia Extends Oil Output Cuts Until Mid-Year to Stabilise Market_1

Saudi Arabia Extends Oil Output Cuts Until Mid-Year to Stabilise Market_1

Saudi Arabia, which benefited from the rally in crude prices last year amid the Ukraine war, has cut oil output in an attempt to stabilise the market.

Last month, the kingdom announced its budget deficit reached 80.9 billion Saudi riyals ($21.57 billion) in the 2023 fiscal year, narrower than the government's previous estimates, as oil revenue dipped amid production cuts.

Oil prices surged on Friday and recorded a weekly again amid expectations that OPEC+ crude producers would extend supply cuts into the second quarter.

Crude prices have been volatile this year, largely due to supply concerns arising from attacks on oil vessels in the Red Sea.

Meanwhile, persistent high inflation in major economies has added to uncertainty regarding the outlook for crude demand, which has capped oil price gains.