“This is a big deal,” warns Nomura’s Charlie McElligott – a man not known for hyperbole – as he reflects on the sudden, dramatic changes occurring in the very deepest levels of plumbing of the world’s supposed most-liquid markets.
Another massively over-subscribed repo liquidity injection this morning, coupled with The Fed’s dramatic loss of control of rates suggest what McElligott calls a “potential mega-shift” in policy from The Fed.
Nomura Chief Economist Lew Alexander shifted his call for today’s FOMC meeting to include:
An announcement that the Fed will resume the expansion of the balance sheet again in coming weeks (in addition to a 25bps cut and likely announcement of ongoing “as needed” repo transactions in order to maintain short-term interest rates within a range that is consistent with the target range for funds rate—however, we still do NOT anticipate an imminent announcement of a “Standing Repo Facility” nor another lowering of IOER relative to the top of the FF target range today…while we also expect the dots to show no further rate cuts at this juncture, despite our “house” call for one more cut in either Oct or Dec)
McElligott’s Bottom line:
Due to the acute nature of the $funding stress dynamic in recent days, I believe the delta of a Fed “balance sheet expansion” headline today (one which would begin imminently) is significantly underpriced in the market and risks catching investors “off guard”.
The market’s “muscle memory” in the post-GFC period has condition many participants into believing that “balance sheet expansion = QE” and risks a “BULLISH risk-asset sentiment shock” (FWIW, “BS expansion = QE” is NOT actually the case per se, as what we think the Fed plans to do is much more “QE-Lite” in order to offset the Reserve depletion dynamic—NOT inject incremental liquidity “above and beyond” to actually “pump up” Reserves).