David Lettermen has a running bit where he drops various objects into a pool of water and asks "Will it float?" After yesterday's chat with Michael Sedacca and Vince Foster for Minyanville, I decided to run an experimental matrix of what FOMC movements may attempt next year. Spoiler Alert: It doesn't look like it floats.
The problem comes from the flood of international cash and low demand for dollar borrowings in the unsecuritized/uncollateralized interbank market. Despite myriad regulatory changes the "old rule" (more like a guideline) that 3 month LIBOR is/should be 14bps over FF continues to calibrate in times of stability. However, as rates are moved upward - in my example with 2 small moves before a 25bp move - Interbank will price in multiple moves (denoted by ++ on chart)...PROVIDED DEMAND INCREASES as we move off ZIRP (a theory we have but could be wrong)
Also, it is reasonable to suspect that Fed attempts to create a soft floor would not be any better with a hard FF target (as before) rather than a range that I suggest here. The range essentially gives cover for the probable consistent downward pressure on FF from "other" sources.
Two possible unwanted outcomes are steady pressure that suppresses interbank rates lower and longer than desired OR a significant jump up in money rate term structures more accurately reflecting the new regulatory environment and the hash reality of the end of "free money."
GC could continue to trade as if in shortage -like now - in either scenario and there is little support for the notion that heavy Death Star participation will change this.
No CB has successfully exited itself from QE. We are going to give it a go...cue Paul and the band for a drum role....Will it float???