Thursday 22 March 2018

Fed funds, Libor and MAGA economics

USD 3-month Libor is currently up to approximately 2.25%, outpacing Fed funds and OIS, as it seems a mix of high Treasury issuance, Fed QE unwinds and maybe some other bank funding factors pushed up Libor.

The FOMC projections now show a terminal Fed funds rate of 3.25-3.5% as the central tendency. If Libor trades 25-50bps higher at that time, then Libor will be at 3.5-4%. 

If the Fed hikes three more times this year to 2.25% and Libor is 2.75-3% at that time, then effectively most of the hiking cycle will have been done, the end of which normally involves a recession. 

3-4% while it is a big move for highly valued asssets and a financial system that is in the hundreds of percent of GDP, it is still loose for an economy growing, 4.5, 5 maybe 5.5% in nominal terms.

However, the Fed's projections don't make any real allowance for a wage-inflation-investment cycle starting, which is what Trump's MAGA policies are trying to support, ie they are trying, in my view, to create a new economic cycle with new drivers, without having a Fed-induced recession in the middle. If those policies are successful then wages should rise, which will squeeze margins and in turn force companies to invest. That should also result in a higher default rate for weaker companies.

If nominal GDP rises to a 5.5, 6 or 6.5% range, the Fed will really be cornered and financial markets very pressured.

Every 100bps in increased Treasury yields costs the Federal government something like $150bn in interest costs on a rounded up $4Tn Federal revenue base.

That said MAGA aims to reduce the CA deficit in favour of domestic jobs and production. If the deficit can improve by a $500bn delta, that could be worth $150bn in taxes and partly offset the rise in interest costs. 


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