Citi's Kang on Fed Normalization
Citi Research's Steve Kang features in his latest "Short-Term Research Notes" a piece entitled, "Let's watch the paint dry," which reviews "balance sheet normalization and its impact on rates." He says, "Fed Chair Yellen likes to say that the balance sheet normalization process will be like "watching paint dry". For longer-term rates, we agree with the sentiment and expect little near-term impact. However, we advise money market investors to keep an eye out as the reserve drain could disrupt the global dollar funding markets and widen XCCY and LIBOR basis. We also review the normalization's implications on Treasury supply." The piece comments, "The Fed is expected to announce the start of the normalization ... most likely commencing from October. We continue to expect only marginal day one-impact on term premium because the market is likely to be pricing much of the effect already, given that the near-term trajectory of the normalization is quite deterministic.... Though we expect little impact on duration, money market rates are likely to be disrupted once the Fed B/S normalization is well underway." Kang adds, "The redemption cap set by the Fed would ensure a slower increase in supply than otherwise, but it is still ramping up quickly in CY 2018/2019 by $226b/$266bn.... Combined with possible fiscal reform in 2018 (the likelihood increased with the earlier resolution of the debt ceiling), we expect to see an increase in coupon issuance in 2018. We pared down our subjective probability of a coupon increase for this November as the short-term debt ceiling suspension reduces the expected funding needs by $200bn (as cash balance is expected to stay low). In our base case, the first increase in coupons is likely to be seen in February 2018. Figure 5 shows our expectations for the net and gross supply of coupons."
