The jump in overnight repo rate has been due to several colliding factors from large Treasury auctions and corporate tax payments. However, both events are well-known beforehand so one must wonder how the repo market could be so unprepared. Our sources also tell us that Saudi Arabia pulled USD from the system to offset weakness domestically from the attack which naturally has added funding stress. The expectation is that the Fed intervenes again today in the repo market but in general market consensus is that the spillover effects are low as the constraints in the repo market can easily be solved short-term.
But the jump overnight repo rates put the Fed in a difficult situation tonight at the FOMC rate decision because the narrative has definitively changed from being that of excess reserves and temporary slowdown coupled with some uncertainty over US-China trade war. The narrative seems to be tight USD funding markets, strong USD is slowing global growth, Fed cannot reduce balance sheet while the US government increases its fiscal deficit and the US-China trade war will persist deep into 2020. The Fed Chair Powell must steer away from the story of a mid-cycle adjustment to that of the world flirting with recession.
The base scenario tonight is a 25bp rate cut with language likely to the hawkish side against current market expectations. It should be clear by now that the Fed is close to losing control over monetary policy and is perceived by the market as being behind the curve.
In Europe this morning car sales showed significant weakness in August and growth turning down again (see chart) whereas China seems to have managed a sustained improvement in its car market. Yesterday’s better than expected ZEW figures on expectations would normally have lifted markets but the current conditions index still declined and today car sales figures show that Europe is in need for more stimulus. However, the ECB cannot do more to help the economy and apparently Draghi’s cry for help from the fiscal side has started talks among governments in Europe. The Dutch government announced yesterday plans for increased government spending in 2020 and cutting taxes.