The Fed’s effective rate is being pushed higher by repo disruption. The Fed had to intervene in the repo market with their first injection since 2008. Following yesterday’s $53 billion repurchase operation, the Fed will add as much as $75 billion in cash to broader markets in order to maintain the key rate inside its target range.
President Trump’s deficit increases and the Fed’s shrinking of the balance sheet will likely see this short-term problem see the Fed be forced to cut the IOER. Fed Chair Powell will need to address the lack of liquidity of in the system, because the banks have been so used to the excess of liquidity that came from QE. Powell will have to decide if they cut rates aggressively or if they deliver liquidity injections.
US stocks markets will be in for a rude awakening if we do not see Fed Chair Powell deliver a 25-bp cut with a somewhat clear signa more are coming. The repo market pressures will likely see the Fed focus on cuts to IOER and eventually we could see liquidity injections, but it might be too soon for that to happen. Any failure to address repo markets would be catastrophic as traders will lose more confidence in obtaining funding at consistent rates and that is the key to overnight financing, a critical component to the economy.
The meteoric rise in energy prices is slowly coming back into the tight range that has been in place for the last three months. Oil is softening after the Saudis noted they are poised to deliver a quick turnaround in reaching pre-attack production levels as early as next month. Energy prices however will continue to remain highly sensitive to the next escalation between the Saudis, Iranians and US.
Today’s EIA report is expected to show a 2.5 million drawdown, this help markets forget yesterday’s API inventory increase of 0.6 million barrels. A surprise build in today’s report could provide some pressure with oil prices, but will nowhere shift the primary focus away from the Saudi-Iranian tensions.
Gold prices seem locked into a tight range ahead of today’s FOMC decision. Gold’s bullish mojo seems to need a dovish cut by the Fed for momentum traders to jump back on board. A 25bp rate cut will not do it for the bullish argument for gold prices, Powell needs to signal more cuts are coming and announce that the risks to economy could even warrant further measures.