Spark Global Limited reports:
As the US economy has restarted, inflation data have repeatedly exceeded expectations, but Labour market data have remained mixed. The FOMC on July 28 did not lay out a specific plan for tapering QE: the Fed remained tolerant of near-term inflation and paid close attention to the Labour market — signals that remain in line with market expectations. But the data and “timetables” over the next two months suggest that market expectations for Fed policy could fluctuate significantly.
We expect us inflation indicators to remain elevated in the near term. At the same time, monthly non-farm employment indicators are likely to show a substantial improvement as unemployment compensation gradually declines and seasonal factors in employment “turn positive”. With macro conditions ripe for QE tapering, the Fed’s Jackson Hole meeting in late August and its rate-setting meeting in late September will continue to be the focus of the market’s trackers — fed watchers could have an unsettled summer.
Is there a consensus to cut QE? — It can be said that everything is ready except the east wind. This is true both in terms of data and technology:
1) The output gap caused by the EPIDEMIC in the United States is close to closing. The PMI of THE ISM manufacturing sector from February to June and the PMI of the service sector from March to June in the United States are both above 60%; As of June, the newly signed orders in the manufacturing industry and the retail consumption of residents were both more than 20% higher than the same period in 2019. Q2 US GDP was $19.4 trillion at constant price, close to our previous estimate of $19.6 trillion “potential level without pandemic”. As a result, the US output gap is expected to close in the third quarter and then turn positive.
2) Inflation expectations are already well ahead of the “average inflation target.” Our analysis shows that the recent INFLATION indicators in the US may continue to exceed expectations. It is expected that the US CPI year-on-year may “break 6%”, the core PCE year-on-year may “break 4%”, and the core PCE is even expected to exceed 3% in the whole year — much higher than the Federal Reserve’s long-term target of 2% under the “average inflation target system”. As we noted earlier, there is likely to be further upward pressure on “reactivation” of goods and services, as well as motor vehicle prices, in the short term.
In addition, the gap between us housing supply and demand will be difficult to close in the short term, and there is still room for further price increases, with continued “spillover” effects on rents and other services to be one of the important factors driving up core inflation in addition to the “restart effect”. At the same time, there is still a large gap in the job market, structural Labour force participation is falling, and wage expectations are rising sharply as a result of fiscal subsidies, and wage increases are sticky.
3) From the technical level, the Fed has been “shrinking the balance sheet” in a real sense by increasing the scale of reverse repos; And the return of SLR constraints on banks has limited the Fed’s balance sheet from expanding much further. While the Fed kept its QE purchases unchanged, with a net monthly increase of $80bn in Treasuries and $40bn in MBS, its total assets at the end of July were up $530bn from March, including $520bn in Treasuries plus MBS.
On a technical level, however, the Fed has already begun to “shrink” its balance sheet using reverse repos, a tool used by the Fed to withdraw liquidity from the market. The scale of reverse repos rapidly rose to nearly $1 trillion between March and July this year, even more than the $520 billion in LIQUIDITY pumped out by the Fed’s QE program during that period. Excess reserves at US commercial banks, a reflection of liquidity in the banking system, were essentially unchanged at the end of July from the end of March; In late June, excess reserves fell for a time, while the scale of reverse repos continued to rise, reflecting the “recovery” of redundant liquidity by the Federal Reserve through reverse repos.