Daily Commentary

MarketMinder’s View: We bring you this longish piece to correct a small, widely held misconception … and because it is an interesting discussion overall. Fed head nominee Kevin Warsh, whose path got clearer when the Justice Department dropped its investigation into outgoing Fed head Jerome Powell Friday morning, thinks it will be beneficial to shrink the Fed’s balance sheet—further reducing the mass of long-term Treasury bonds and mortgage-backed securities it bought under “quantitative easing” after 2008’s financial crisis and during COVID lockdowns. He argues doing so will enable the Fed to cut rates. The article presents this as a tricky conundrum, noting markets freaked when the Fed (according to some) moved too fast. This is where the misperception comes in: Markets didn’t wobble because long rates rose. Rising long rates steepen the yield curve, which promotes more lending and growth. Cutting rates aggressively alongside this would risk turbocharging lending and overheating the economy. Low short rates don’t offset high long rates. They work together to widen banks’ net interest margins. The real reason markets wobbled is what the article spends its final half discussing: a drop in interbank liquidity as reserves held at the Fed dropped (the Fed’s assets and liabilities match, so when it lets assets roll off its balance sheet, there is a corresponding drop in reserves). Shrinking the Fed’s balance sheet thus requires some adjustment in how banks manage short-term liquidity. The article discusses ways this might happen, but the main takeaway is the process is probably long and deliberative, sapping surprise power. No one wants a liquidity crunch. The solution will probably be rather operational and boring, like the Fed’s move to resume transacting in short-term Treasury bills a few months back—returning to its traditional means of managing liquidity with lower reserves. There is some attention on the Fed’s interest payments on reserve balances, but the Fed adopted this policy to put a floor under the fed-funds rate 20 years ago after long-running difficulties keeping market-set rates in line with its target when liquidity was higher. So keep an eye out, but we don’t view this as an action item for now.

MarketMinder’s View: While we agree it wouldn’t be a net benefit if every country bordering a maritime chokepoint started charging tolls, the sentiment here seems like an overreaction to one government official’s offhand comments. Yes, “Purbaya Yudhi Sadewa, the Indonesian finance minister, told a symposium in Jakarta: ‘Ships pass through the Malacca Strait without being charged – I’m not sure whether that’s right or wrong. Iran is now planning to charge ships passing through the Strait of Hormuz. If we split it three ways – Indonesia, Malaysia and Singapore – it could be quite substantial. If only it could be like that. But it is not like that.’” That wasn’t exactly a “we are going to do this,” nor even a “we are thinking of doing this.” Indonesia’s foreign minister already quashed the idea, calling tolls not “appropriate.” So did Singapore’s foreign minister, important given Singapore’s proximity. “He said: ‘The right of transit passage is guaranteed for everyone. We will not participate in any attempts to close or interdict or to impose tolls in our neighbourhood.’” Given investors tend to fight the last war, expect this chatter and fear to linger. But maritime law requires free and open passage, and the Strait of Hormuz is a special case in that Iran never ratified the UN’s Conventions on the Law of the Sea. Indonesia did. Markets move most on probabilities, not possibilities.

MarketMinder’s View: UK retail sales beat expectations in March, and it wasn’t all because people raced to stock up on fuel before prices jumped. Total retail sales volumes rose 0.7% m/m, with gas stations’ 6.1% jump contributing, but sales ex. gasoline still rose 0.2%. The lone category declining was food stores at -0.8% m/m and we are aware of no theory that suggests people will eat less if fuel prices rise more—both are considered rather inelastic goods (i.e., demand doesn’t materially sway on price). No, as in the US, there isn’t yet much evidence higher gas prices prompted substitution, considering department stores (1.1% m/m), clothing (1.2%), household goods (0.6%) and e-commerce (1.4%) all jumped, per the Office for National Statistics’ report—which reports warm weather and new product launches brought shoppers out in droves. And with sales values also up in these categories, growth wasn’t all from discounts attracting penny-pinching shoppers trying to juggle high fuel costs. Seems to us the UK economy continues doing better than expected. And with sentiment remaining dim, as the article highlights, there seems to be room for positive surprise if early-year growth turns out not to be merely “the calm before the storm.”