As the fallout from Jackson Hole continues to ripple through markets, investors have their eyes on more drama stemming from the central bank. The Federal Reserve this week is set to raise the throttle of its quantitative tightening (QT) program by picking up the pace at which it unwinds its balance sheet. The move is a stark reversal of pandemic-era bond buying, which saw the central bank nearly double its balance sheet to nearly $9T from $4.2T over the past two years.
Bigger picture: Unlike the large rate hikes being broadcast by the Fed – which have been quick to capture investor attention – QT is a more opaque way of tightening financial conditions. Note that the central bank is not selling its Treasury holdings outright, but is rather letting them mature to shrink its balance sheet. After an initial few months at a slower pace, monthly caps for offloading Treasuries and mortgage-backed securities are set to double to $60B and $35B, respectively, compared to the peak combined rate of $50B the last time the Fed trimmed its balance sheet in 2017-2019.
The whole thing is somewhat of a complicated accounting process, involving settlement windows and redemption caps, but at a basic level, it ultimately reduces the supply of bank reserves and drains money from the financial system. Some safety valves have been implemented this time around, like the Standing Repo Facility, after chaos in the repo market prompted an early end to the last QT program in 2019. The new facility will allow primary dealers to borrow more reserves from the Fed against high-quality collateral, but some caution it might not be enough to stave off liquidity issues, and could complicate Chair Powell’s plan to raise rates and bring inflation under control.
Commentary: “I don’t think there is appreciation for QT, by markets or the Fed,” said Solomon Tadesse, head of quantitative equities strategies North America at Societe Generale. “In the end, if QE mattered, so will QT. It might not be totally symmetrical, but there will be a meaningful impact.”
The housing market comes into focus at 9 a.m. as the S&P CoreLogic Case-Shiller National Home Price Index reveals trends for the end of the second quarter. The data for June will highlight resales of single-family homes in 20 metropolitan regions across the nation at the start of the typically hot summer buying season. Many have recently weighed in on the industry, especially as the Fed continues its aggressive rate hiking cycle, though some say the fundamentals are still intact despite current volatility.
Quote: “We still will have, even for the deals that are under contract, a very high cancellation rate. It’s just hard to put deals together because the economy is [in] a remarkably uncertain time,” noted Redfin (NASDAQ:RDFN) CEO Glenn Kelman. “In 2007, we predicted there would be a crash. We were selling homes to people who couldn’t afford them, where they couldn’t even make the first mortgage payment. And that’s just not the case. Right now, there are trillions of dollars, and people who are buying homes have great credit scores.”
Average mortgage rates reached 5.2% in Q2, according to Fannie Mae, and while that represents a major increase from the 3.2% seen in the first week of January, it’s still low by historical standards. Furthermore, mortgage rates are projected to decline next year, easing back to an average of 4.5% in 2023.
Correction? Most of the worries in the housing market center around whether the U.S. plunges into recession. In that event, Moody’s Analytics forecasts that house prices will fall between 5%-10%, and in 183 overvalued areas, properties could crash 15%-20%. It comes as sales of new single-family homes slid to their lowest level in nearly seven years in July, tumbling 12.6% to a seasonally adjusted annual rate of 511K. (2 comments)
Trouble is brewing in Pakistan, though the nation has been able to secure some help from the International Monetary Fund. The worst monsoon rains in decades have flooded the country, with nearly a third of Pakistan underwater, countless homes washed away and crucial farmland destroyed. The flooding has even killed more than 1,000 people, and affected more than 33M – or one in seven Pakistanis – according to the National Disaster Management Authority.
Snapshot: The natural disaster has weighed on Pakistan’s economic outlook, which is already suffering from severe inflation and a political crisis. Skyrocketing prices for food and fuel saw inflation reach 45% last week, while the rupee hits record lows against the dollar and forex reserves erode. Adding to the instability, Prime Minister Shehbaz Sharif recently took over from arch-rival Imran Khan, who was ousted in April, though fresh elections must be held by the second half of next year.
The latest IMF program, one of a dozen since the 1980s, had stalled multiple times under the Khan government, which opposed unpopular loan conditions like austerity measures. However, the Washington-based institution has changed its stance in recent months, with Sharif’s government reversing energy subsidies and imposing fresh taxes. A fresh tranche of $1.1B was released late Monday, while the nation’s bailout package was increased to $6.5B.
Outlook: Many economists have warned that Sri Lanka could have been the first domino to fall in a global economic crisis set to envelop many poorly-managed developing countries. While Pakistan seems to have avoided a default threat, things could come back to bite if it fails to implement corrective policies and reforms that remain essential for economic stability. Other South Asia countries like Bangladesh and Nepal are also struggling, and any missteps could spell trouble across the emerging markets.
U.S. airline sales took a sizable step back during the last week of data tracked by Bank of America, and the team thinks that if the booking softness is not reversed in the next couple of weeks, it would indicate more of an underlying demand problem and create risk to the current outlooks for Q3.
Statistics: Bookings were down -23.6% vs. the level seen in 2019 for the week ending August 21 compared to the prior week’s level of -9.3%. System volume was down 23.5% vs. 2019 and pricing edged 0.1% lower vs. the pre-pandemic level.
“We typically only see this type of weekly change around holidays, so the change is surprising,” noted BofA analyst Andrew Didora. “The only comp issue we have found is that in 2019 Hurricane Dorian was approaching the US at the end of August, which could have pulled forward some bookings.”
On watch: American Airlines (AAL), Delta (DAL), Southwest (LUV), United (UAL), JetBlue (JBLU), Spirit (SAVE), Hawaiian Holdings (HA), Alaska Air (ALK), Allegiant Travel (ALGT), Mesa Airlines (MESA), SkyWest (SKYW), Sun Country Airlines (SNCY) and Frontier Group (ULCC). (60 comments)
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