“Caught observers off guard, even as they understood the reason for the change”

As the saying goes, “needs must when the devil drives”. We have no problem understanding the Fed’s decision to announce (at 7pm last night) that the details of the BTFP program needed to be altered. The problem was the overly juicy arbitrage, whereby banks could use the BTFP window to flip cash from the Fed into the RRP and pocket the not-insubstantial difference. We were impressed by the chutzpah involved in arbitraging two Fed facilities!

Don’t think we are judging our banker friends: we also believe it is a moral responsibility to accept any free money (or other ancillary benefits!) we can find. The change does, however, come with some potential intangible consequences, where playing Calvin Ball “can undermine the trust people have in future programs” (the counterargument is, of course, a quibble about the letter vs spirit of a law). But leaving aside potential Star Wars references (“I am altering the deal. Pray I don’t alter it any further.”) markets have been reminded again not to take anything for granted. Remember the Mark Twain quote about “what you know for sure that just ain’t so”.

In the meantime, the ECB’s Lagarde continued her efforts to keep the horses from bolting: the “ECB’s policy trajectory remains firmly data-dependent”. The latest GDP numbers undermined expectations of a cooling economy (or rather, a less red-hot economy) at the same time that the most recent reading of a quick and dirty “Nominal GDP Now” (Atlanta GDP Now + Cleveland Fed Inflation Nowcast) projection has the US economy growing at more than 5% in Q1.

Inflation optimists (or pessimists, depending on which side of the bond trade you’re on) point to the latest Truflation reading, which remains below the Fed’s 2% target (augmented by today’s PCE reading) and the New Tenant Rent Index (even the devil can quote scripture) is showing signs of easing price pressures in the housing market.

But it’s probably a mistake to place too much faith in slowing shelter components in the CPI index. It’s not that we don’t trust the Fed when it tells us that it believes it has the scope to cut rates. It’s just that we might place more emphasis on the “believes” and less on the actual “scope”. In the same way Turkeys don’t vote for Christmas, incumbent UST officials don’t generally hanker after a move back to academia. The market thinks we will get 140bps of rate cuts over the next 12 months. Things might need to slow down a bit quicker.


P.S. The latest Boeing debacle supports the idea that (if the incentives remain the same) a tiger can’t change its stripes.