Submitted by Taps Coogan on the 7th of January 2019 to The Sounding Line.
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CNBC‘s Rick Santelli recently spoke with National Alliance Securities’ Andy Brenner about yield spreads and the Fed’s balance sheet. They both warn that compressing spreads leave little room for treasury rates to go much lower and that, as the Fed’s explosive balance sheet growth begins to temper, markets may be headed for a much rougher 2020 than expected.
Some excerpts from Rick Santelli and Andy Brenner:
Andy Brenner: “I think the big surprise this year is going to be higher rates and a steeper curve. The same people that told us in 2018 that in 2019 we were going to have the 10-year at 3% are the same people that are telling us they’re pretty sure its going to be 1.8%. We see the 10-year going to 2.2%… but it’s not going to happen today. We’ve got to get through the Middle-Eastern turmoil…”
Rick Santelli: “…We are so compressed in yields across the globe, whether some countries have negative yields, that the notion of being able to compress yields much lower is difficult, even with a geopolitical situation, which leads me to the next big obstacle, central banks’ big balance sheets… We are getting close to (balance sheet) levels we haven’t seen that were the top of the iceberg, $4.5 trillion…”
Andy Brenner: “… Since September, the Fed has been growing their balance sheet at an annualized 30% rate. The repo situation really should have been handled differently, but the way they handled it was to increase the balance sheet. That will end sometime in the first quarter and we think that things are going to get a lot hairier then, including credit spreads widening, higher interest rates, steeper yield curve, but not an equity market correction right away, but that will happen.”
Indeed, the massive increase in the Fed’s balance sheet, stemming from recession concerns in first half 2019 and repo market failures in fourth quarter, has rocketed financial markets higher. That strong performance has led to sanguine market forecasts heading into 2020. The problem, of course, is that while the Fed’s balance sheet has been growing at the fastest pace since the depths of the Financial Crisis, it is not going to continue to grow that fast. Over $100 billion of temporary repos that the Fed injected to handle end of the year liquidity requirements are now draining off of their balance sheet. Their $60 billion-a-month ‘Not QE’ program is scheduled to expire sometime in the second quarter. Unless the Fed is scared into scaling up or extending its liquidity injections yet again, the liquidity tsunami is going to turn into a liquidity trickle in the coming months.
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