Dot plot, Fed futures and Peter Zeihan

Stocks around the world are trading in a sober mood today; Dow Jones, Hang Seng, Nikkei, Kospi are showing various forms of red however the changes are not significant enough to paste an explanation (like profit booking, value buying, risk on, risk off etc). US 10-year treasury yields are hovering around 1.62 levels which is the near term high. The Dollar Index is pushing 92 again. Gold is around 1735$/oz and Brent crude is around 68$/bbl levels. Offshore Chinese Yuan is trading at 6.50 which is a far cry from the 7.2 levels seen last May. This is some 10% appreciation from the lows. The Indian Rupee trades around 72.50 and 10-year yields at 6.17. Overall, on the market news, they seem to be bracing themselves for an event risk in terms of the FOMC meeting by not taking any aggressive positioning.

We have written on the expectation around the FOMC meeting for the last few days. Overall commentary is expected to be dovish and any good news will be laced with some caution. Sample this, “Economy is improving but the risk remains”, “Reopening is on track, but we monitor the surge in cases in other parts of the world closely”. But apart from the verbal assault, the meeting gains significance around two points. The first one is the release of the dot plot. Fed watchers know the dot plot as the future interest rate trajectory in the individual opinion of committee members. If the majority choses to prepone the timing of the first hike to 2023, markets might construe it has a hawkish signal. The market bets as represented by the CME fed funds futures are taking an even more of an aggressive view with a sizeable chance of first hike arriving by Dec 2022 itself. A lot of these bets will be reconfigured today.

The second issue of relevance is about a technical adjustment which the Fed did last year on the way the big US banks are required to compute the SLR or Supplementary leverage ratio. Jargon aside the SLR determines how much capital needs to be set aside relative to the assets held by the banks. Fed in April last year excluded the stock of USTs held by the bank from this computation. This exemption is expected to run off by March 31^st. In case it expires, many banks will be required to sell treasuries to be compliant of the rule. This also hampers their ability to participate in future treasury auctions. Lack of demand can spike the cut off yields in the primary markets which will then rub off to the secondary space. In his Congress testimony last month Fed Chief Powell deflected the queries on the possible extension of relief.

Sometimes the readers would wonder why so much discussion happens on Fed and its policies in a piece which is supposed to be covering the developments across the globe. The answer lies in the way modern finance works with unimpeded capital flows searching for higher yields. Most of such flows are generated in developed countries with the US being the fountain head. In his book Disunited Nations, author Peter Zeihan opines that the financial power of US is amply backed by the geo-political power it possesses. Hence the questions about the reserve currency and safe haven harbour should not be looked only through the lens of economic logic (profligate US govt, money printing by Fed). After analysing each and every major country on a number of parameters (geography to naval skills to commodity availability etc ) Zeihan concludes that the current world order is expected to continue for foreseeable future.