QQQ - It's Already Broken But Powell Insists Not To Fix It (For Now)

2023-03-24 12:41:08 ET

Summary

• Fed's balance sheet conundrum.
• Credit markets are shouting SOS.
• It's now a matter of when (how quickly the Fed folds), not if.

At the same time that the Fed keeps conducting QT (i.e., acting to shrink its balance sheet), the Fed's balance sheet has expanded significantly for the second straight week.

Fed's balance-sheet is now up ~$400B over the past two weeks, only ~$200B shy from the all-time high.

On one hand, the Fed is hiking rates to fight inflation, and Fed Chair Powell is warning of more rate hikes in the coming months.

On the other hand, the Fed is creating new dollars (increasing liquidity) through special programs aiming to help banks' immediate liquidity constraints.

Taking into consideration banks' (loss of) appetite to lend money these days, this injection of liquidity is unlikely to spill into the economy.

Increasing liquidity isn't the same as doing QE.

The Fed isn't printing money and buying bonds, but it's creating new dollars and lending these dollars to banks while using the banks' bond holdings as collateral.

These newly-created dollars are supposed to be paid back quickly, and the newly-held securities in the Fed's balance sheet will be sent back to their lawful owners.

What is likely freaking everybody out today is the possibility of a foreign central bank maxing out the FIMA (=Foreign and International Monetary Authorities) repo facility.

Deutsche Bank Aktiengesellschaft ( DB ) obviously doesn't help improve the sentiment, either.

The German bank's five-year credit default swaps ("CDS") jumped to 173 bps yesterday, up from 142 bps on Wednesday - making this the largest DB CDC single-day rise in its history!

The bank's Additional-Tier 1 (aka AT1) debt is also under extreme pressure. The yield on DB's 7.5% AT1 USD-denominated bond is ~23%, twice as high as where it traded only two weeks ago.

That, of course, is affecting all markets - credit and equity alike.

With the two-year US Treasury volatility already exploding over the past few days, these developments are neither going to allow for a quiet trading day on Friday, nor would they allow ECB (and Fed) policy makers to enjoy a peaceful weekend.

Remember: the Fed typically keeps hiking rates until something breaks, and we believe it's safe to say that something broke about two weeks ago with the fall of SVB Financial Group ( SIVB ) and Signature Bank ( SBNY ), as well as with everything that has happened since then: the CS - UBS forced marriage, First Republic Bank ( FRC ) still running on very shaky ground, and now DB.

Everybody knows that something is broken already, including Powell; however, he insists on being the last guy in the room to shut off the (tightening) lights.

Against Powell's not seeing rate cut on the 2023 horizon, investors are now pricing in more than 110 bps of rate cuts by the end of January 2024.

That's a stunning, unprecedented, divergence.

DoubleLine's Jeff Gundlach expects the Fed to cut rates "substantially soon," and he's definitely not alone in this "Powell is going to fold" camp.

Gundlach is advising us to take into consideration that he's wrong 30% of the time, but I think this prediction of his isn't going to hurt his (self-watched) record in being correct 70% of the time.

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