Top of the Street: Inflation and easy money, from QE to QT, onward corporates soldier and foreign banks reach for repo

The Fed could tip its hand on its inflation view this week but will almost surely start quantitative tightening. Technicals and fundamentals help credit. Foreign banks reach for repo. Contributions from Barclays, JPM and Milepost.

Markets: Inflation faces off against easy money at the FOMC this week
The Fed will wrestle again this week with the competing pressures of low inflation and easy financial conditions. Last week’s CPI did lift some hopes that the summer’s low inflation was only temporary and raised the odds of a Fed hike in Dec. Month-over-month headline inflation came in at 0.4% (0.3% consensus), year-over-year at 1.9% (1.8% consensus) and core CPI at 1.7% (1.6% consensus). Fed fund futures repriced the chances of a Dec hike from 20% to 50%. NY Fed President Dudley noted last week that if low inflation is transitory, “an easing of financial conditions may warrant a somewhat steeper policy rate path.” Low long rates and tight credit spreads have kept US financial conditions easy despite 75 bp of Fed tightening since Dec. The Fed will need to keep its options open this week for a Dec hike, but the market will need more evidence of normal inflation this fall before pricing many hikes beyond that. See Barclays, Global Rates Weekly, 14 Sep 2017. (Barclays, Milepost).

Markets: From QE to QT
Quantitative easing likely turns into quantitative tightening this week when the Fed announces the official start to reductions in its $4.2 trillion portfolio. The Fed has signaled that it will let up to $6 billion of its Treasury holdings and $4 billion of its MBS roll off monthly starting in Oct. Those targets will rise to $12 billion and $8 billion respectively in Jan and keep rising quarterly until reaching $30 billion and $20 billion respectively next Oct. The process should reduce bank reserves held at the Fed, tightening the money supply. The Fed has signaled these changes for months, and their implementation should have little immediate effect on either the Treasury or MBS markets. See Barclays, Global Rates Weekly, 14 Sep 2017. (Barclays, Milepost).

Markets: Onward corporates soldier
Although spreads on corporate debt widened from early Aug through mid-Sep, the odds favor a return to tighter levels, according to JPMorgan. Light supply should help. The net supply of corporate debt should finish the year at $582 billion, down $70 billion or 11% from last year. Tax reform, which could trim the advantage that debt now has over equity funding, could cut supply further. Steady US growth has helped corporate spreads, too, with a weak US dollar buoying earnings at non-financial issuers. See JPMorgan, US Fixed Income Markets Weekly: Corporates, 18 Sep 2017. (JPM, Milepost).

Markets: Foreign banks welcome the repo man
Government money market funds have poured an increasing share of their assets into repo this year, even excluding the Fed’s repo program. Repo balances this year have jumped $338 billion while Treasury debt has dropped $164 billion. The big new borrowers: foreign banks. Seven of the 10 largest repo borrowers are foreign banks, with French banks leading the way. Borrowing against high quality liquid assets may be their most efficient source of US dollar funds. See JPMorgan, US Fixed Income Markets Weekly: Short-Term Fixed Income, 18 Sep 2017. (JPM, Milepost).