巴黎银行-美股-宏观策略-美国：美联储正常化才刚刚开始-20190321-9页.pdf

|FOCUS 21/03/2019 1 Long 5y5y US inflation swap forward:Feds dovish rhetoric,little concern over inflation risks and reassessment of their inflation-targeting framework support wider breakevens.Entry:2.07%.Target:2.35%Current:2.29%.Long 2y UST vs.OIS:The Fed will reinvest fully from Q4.We expect the Fed to shorten SOMA duration via T-bill reinvestment and consider a repo facility allowing front-end USTs to richen.Entry:16.5bp.Target:0bp.Current:16.5bp.TRADE IDEA FOCUS|US 21 March 2019 US:Only the beginning of the end of Fed normalization KEY MESSAGES The Fed will end balance sheet normalization in September,with full reinvestment to commence only from October.Marchs big dovish revision to dots,balance sheet announcement and little concern over upside inflation risks reinforce our views of gradual curve steepening,higher inflation breakevens and lower rates volatility(as the Fed attempts to shrink the distribution of rates).Whilst the Fed may have satisfied market expectations,its latest actions are necessary but not sufficient to control short-end rates and financial conditions.This is just the beginning of the evolution in the Feds monetary policy implementation framework,not the end.Fed to start full SOMA reinvestment in Q4.The Fed has finalized plans for the end of balance sheet reduction,consistent with our expectations.The monthly cap on UST roll-off will be halved to$15bn from May.Net UST supply to the market will fall materially only from Q4.The Fed suggests reinvesting MBS prepayments into USTs across the curve.The reinvestment plan remains subject to ongoing debate.Too little,too late?Despite the Feds announcement to moderate reserves contraction from May,overnight fed funds has risen above IOER!In coming meetings,the Fed will be focused on bank demand for reserves and the long-run asset composition and duration(ie,final reinvestment plan).We suspect the Fed will implement the following this year:(i)shortening duration via T-bill reinvestment,(ii)adding assets against currency growth,(iii)reducing foreign repo pool,and(iv)new standing repo facility.Please refer to important information and MAR disclosures at the end of this report Fig.1:Projected Fed SOMA(current reinvestment plan)Fig.2:Roll-off cap on USTs to halve in May,end from October Sources:Federal Reserve,BNP Paribas,Macroboond Sources:Federal Reserve,BNP Paribas G10 INTEREST RATES Shahid Ladha,Head of Strategy for G10 Rates Americas|BNP Paribas Securities Corp.|FOCUS 21/03/2019 2 Fed tightening has reduced demand for USTs In addition to the supply of duration during Fed roll-off,normalization has also likely constrained demand for USTs.Banks facing lower LCR coverage as reserves shrink still favor holding reserves at IOER given regulatory,intraday constraints.Overseas UST demand remains weak,given little official reserve allocation and private overseas accounts deterred by the massive cost of USD hedging(Fig.5)Solutions to add liquidity and steepen curve Six months of further Fed balance sheet normalization will not relieve the pressure on front-end rates,especially with supply running at record levels(UST auctions of$230bn+/month),limited overseas demand and upward pressure on front-end paper.The Fed will need to act decisively on its monetary policy implementation toolkit.Adding front-end liquidity and gradually steepening the yield curve would be an efficient way to reduce liquidity/credit risks,continue with near-term normalization and hopefully improve the demand function for US Treasuries(beyond reinvestment).The longer the Fed takes,the bigger and bolder the solution may need to be Shorten SOMA duration with T-bill reinvestment We still expect the Fed to shorten SOMA duration by reinvesting MBS prepayments into T-bills,as discussed in our Deep Dive:After the rain,Comes the sun.Shrinking reserves due to currency growth remains unsustainable in our view and we do not expect it continue beyond this year(if it happens at all).Repo facility:We expect the Fed to consider implementing a standing repo facility(fixed price,full allotment)to better administer front-end rates.The facility should reduce liquidity risk and increase substitutability of reserves for USTs.The success of any such facility depends on the diversity of participants,competitiveness of the rate(not much above the upper Fed target band),LCR efficiency for banks using it and no stigma in its use.Foreign RRP facility:Reducing the Feds liabilities by up to$250bn would make space for reserves and result in increased demand for T-bills from overseas.Liquidity contraction for at least six more months Following the Feds revised“Balance Sheet Normalization Principles and plans”,we expect reserves will contract by more than$300bn over the remaining months of normalization to$1.25trn.This level is within our estimates of scarcity($1.2trn+$150bn volatility buffer,based on previous work).The current intention of not increasing SOMA assets to offset organic liability growth(currency in circulation)would reduce reserves by a further$100bn/year.This is not a sustainable state in our view.Front-end rates still problematic for the Fed Effective fed funds set above IOER for the first time since 2008!The rise in EFFR occurred with increasing volume implying potential liquidity needs from financials into quarter-end.The Fed remains in danger of losing control over its policy target rate.Signs of oversupply of front-end instruments is clear.Since the start of normalization in late 2017,front-end rates(T-bills,repo,and EFFR)have cheapened sharply vs.IOER(Fig.3).Expect changes to policy implementation soon G10 INTEREST RATES Fig.3:Front-end cheapening with Feds QT Fig.4:UST net supply to fall in 2020 Sources:Bloomberg,BNP Paribas,Macrobond Sources:US Treasury,Federal Reserve,BNP Paribas Fig.5:USTs unattractive for FX-hedged investors Sources:US Treasury,BNP Paribas,Macrobond Shahid Ladha,Head of Strategy for G10 Rates Americas|BNP Paribas Securities Corp.|FOCUS 21/03/2019 3 End of Fed balance sheet normalization We updated our analysis(charts and tables)on the Feds balance sheet following the details on timing and size of reinvestments from the Feds March FOMC statement.For the purposes of illustration,we assume here the Fed will reinvest all UST and MBS reinvestments into USTs across the curve(and there is no offset to currency growth).Fig.6:Evolution of Fed balance sheet Table 1:Corresponding Fed assets and liabilities level Sources:Federal Reserve,BNP Paribas Sources:Federal Reserve,BNP Paribas Fig.8:Roll-off cap on USTs to halve in May,end from October Sources:Federal Reserve,BNP Paribas Sources:Federal Reserve,BNP Paribas Fig.7:Fed balance sheet Stock vs.Flow Table 2:Flow of Fed balance sheet assets Sources:xxx,xxx,BNP Paribas G10 INTEREST RATES Shahid Ladha,Head of Strategy for G10 Rates Americas|BNP Paribas Securities Corp.Legal Notice This document has been written by our Strategist and Economist teams within 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