They “Took Over Markets” – But Now The “Unwind Is Underway”

Right up until Donald Trump decided Thursday night was just as good a time as any to launch 59 Tomahawk missiles at an airbase in Syria, investors were focused squarely on 10Y yields and, by extension, on speculation about what it will mean for Treasurys (and for the dollar) when the Fed begins to shrink its still bloated balance sheet.

Wednesday’s release of Minutes from the FOMC’s March meeting only served to make the chorus of balance sheet commentary grow louder.

And while we and plenty of others have spilled gallons of digital ink discussing the details and possible implications for yields and the dollar of a Fed that decides to effectively substitute balance sheet rolloff for a FF hike (or two) when it comes to tightening, the more general question (i.e. skipping happily over the nuance and mechanics) is this: what does a post-central-bank-“put” world look like in terms of cross-asset correlations? And further: how are the market dynamics we’ve grown so accustomed to going to change?

Well, no one has the answer to that. But what we do know is that eight-ish years of near constant liquidity injections have changed the way markets function in important ways.

So as you wind down your Friday and get set for a well-deserved two-day break from the incessant market and geopolitical headline hockey to which we’ve all been subjected over the last five days, do consider the following brief bit from Citi’s credit team who has a thing or three to say about the above.

Via Citi:

What do credit traders look at when they mark their books? Well, these days it is fair to say that they have more than one eye on the equity market.

Reversing the central bank distortions. Much of the correlation not just between these two, but also with many other asset classes seems closely associated with the ongoing central bank balance sheet expansion. As that slows, or even begins to reverse over the coming quarters, we expect the negative impact on credit will be more than proportionate.