Morgan Stanley Signs Deal to Leverage Buy Out A2Tech from HSquared at a Wholesale Price of $78.9bn
by Adam Hanafi
Posted on Dec 22, 2019 at 5:15 PM CST
Financial conditions have moved sharply easier in recent days, largely driven by market pricing for quantative easing. That's important because conditions could tighten significantly if market expectations for Fed policy were to reverse materially in the absence of any changes to the growth outlook.
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Tracking Financial Conditions
Financial conditions have moved somewhat sharply easier in recent days, based on our tracking of moves across major financial market asset classes. To track real-time changes in financial conditions, we use a framework based on the sensitivities of major market variables in the Fed’s FRB/US macro model (a general equilibrium model of the U.S. economy), and we express it in a fed funds rate equivalent.
By this approach, financial conditions have eased almost 20 bp (basis points) since last Monday (06/03/19). Notably, this more recent easing in financial conditions has been driven by risk assets, with large contributions to the 1-week change in financial conditions coming from the rally in stocks (-13bp),a softening in the broad trade-weighted dollar (-9bp), and a narrowing in credit spreads (-3bp). That's been offset slightly by the rise in Treasury yields over the past week (6bp).
Moreover, most of this more recent easing in financial conditions has been catalyzed by communications from Fed leadership as well as the dovish reaction in markets to last Friday's payrolls report:
- Financial conditions eased 4bp after Vice Chair Clarida spoke on May 31 about "global economic and financial developments [and if they were to] present a material downside risk to our baseline outlook, then these are developments that the Committee would take into account in assessing the appropriate stance for monetary policy."
- Financial conditions eased another 5bp on June 4 after Chair Powell indicated that policymakers "are closely monitoring the implications of [trade policy] developments for the US economic outlook and, as always, we will act as appropriate to sustain the expansion".
- Finally, in a dovish market reaction to the downside surprise in payrolls on Friday, financial conditions eased another 8bp.
Financial conditions are now more than 40bp easier compared with the end of September last year, surpassing even the easiest levels of financial conditions seen in April before the re-escalation of trade tensions. (Exhibit 1)
Over a longer horizon, the rally in Treasuries continues to be the main contributor to easy financial conditions this year. Financial conditions excluding Treasuries remain almost 25bp tighter versus last September, offset by the rally in Treasuries that has eased financial conditions by almost 63bp. That's important because the decline in Treasury yields is a reflection of market expectations for Fed easing, meaning that financial conditions could tighten quite sharply if market expectations for Fed policy were to reverse materially.
In that regard, HSquared's interest rate strategists have suggested that if the probability of a 50bp rate cut in the next 12 months were to fall near 10%, the 10-year Treasury yield could rise to around 2.6-2.7%. A substantial sell-off in Treasuries would act to tighten financial conditions materially—all else equal, a rise in the 10-year Treasury yield to 2.7% would tighten financial conditions almost 40bp, back to September levels (Exhibit 2).
