background image

Macro Digest: Watch financial conditions for timing next Fed action

Macro
Picture of Steen Jakobsen
Steen Jakobsen

Chief Investment Officer

Summary:  Equity and bond markets both sold off yesterday after Powell failed to provide any hint of any incoming Fed put. Rest assured, the Fed will eventually have to act, but will likely do so only once financial conditions have deteriorated sufficiently to force its hand. Today we look at the market developments that will indicate the Fed is finally set to send in the cavalry once again.


What: Powell and FED is being pushed by market – this is analysis  of WHEN has financial condition tighten too much?
Answer: another 1 standard deviation decline in financial conditions
Action: Await Fed signal (and begin to position once the Answer is triggered)
Trends: EURUSD had broken lower, another layer of Gold support broken, US yields testing YTD highs

Yesterday, I wrote that it is far too early for the Fed to act on yield curve control, a message the market was clearly not prepared to hear, as equities and treasuries sold off heavily when Fed Chair Powell essentially shrugged off the recent rise in treasury yields as only something that “caught his attention”. It should not have been such a surprise, as Powell is following the script that the Fed has to follow – that it will only act due to financial market considerations on a material decline in financial conditions, one sufficiently large to threaten the fulfilment of their dual inflation/employment mandate.

The most interesting set of comments yesterday from Chairman Powell on WSJ webinar were these:

“I would be concerned by disorderly conditions in markets or a persistent tightening in financial conditions that threatens the achievement of our goals,” Mr. Powell said Thursday. He added that the Fed is looking at “a broad range of financial conditions,” rather than a single measure.

This makes clear that Fed policy will be driven by Financial Conditions – and Bloomberg has a useful measure of US financial conditions, shown below. As the graphic shows, conditions are still positive and would have to decline about 1 standard deviation to about -0.50 from the current 0.40 to get to their worst levels since recovering from the pandemic reaction last spring. That level was just before the US election, by the way.

05_03_2021_SJN_Digest_01
Source: Bloomberg

To anticipate potential moves in this index – you can align the factors in the list by volatility – of course the stock market has the “fastest speed (volatility)) – meaning a very large move in the stock market could force the financial conditions index into territory where the Fed will intervene.

Below I have made a basic chart of Bloomberg Financial Conditions with panel including Z-score (21 days – or about one month) and the Nasdaq 100 measured by the same one-month rate-of-change (ROC)… in order to gauge the speed of the move up or down.

05_03_2021_SJN_Digest_02
Source: Bloomberg

I may be “stretching” the argument and correlation here, but clearly – a cross-over move can be defined in this chart, meaning we are within a standard deviation of seeing the next action from the Fed – whether from a sufficiently large further correction in equity market and especially if credit spreads (still showing no strain) becomes unanchored.

What will the next Fed action be? Most likely an addressing the turmoil in repo and funding markets caused by the US Treasury drawing down the majority of the $1.6 trillion in its General Account at the Fed. But remember: this is merely short-term noise bigger story: We have had a major paradigm shift from a focus on financial stability to a focus on social stability, a move which changes everything, including potentially the velocity of money, inflation outlook and growth. The next level in the 10-year US treasury yield is 1.65%, and then there is some mortgage convexity hedging between 1.7-1.8%, which could lead to 1.90/1.95%, which is way above my earlier trend channel (see below).

05_03_2021_SJN_Digest_03
Source: Bloomberg

My medium term channel was established mid-January..

Safe travels and nice week end

Steen Jakobsen

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.