Economy

The print is expected to show a modest increase in inflation, with headline CPI rising by 0.1% month-over-month (MoM) and core CPI by 0.3% MoM. According to BofA, this would be more of a “bark than bite” moment for the markets, with limited implications for the Federal Reserve’s path.While the initial reaction to a 0.3% core CPI print might lead to some volatility, especially in the US Treasury (UST) market, the impact will be short-lived. They project core PCE inflation at 0.18% MoM, which aligns with the recent trend and is consistent with the Fed’s 2% target.“This, in our view, should encourage market pricing for a 25bps cut in November,” strategists said, unless inflation accelerates more than expected. For the market to consider a higher chance of no rate cut, BofA notes that a core PCE reading of 0.3% or higher would be necessary.In the bond market, BofA expects a resurgence of buying interest in USTs if the CPI report confirms that disinflation remains on track.“CPI will be a test for whether buyers return to the UST market after the recent selloff,” BofA noted.A print in line with their forecast would likely lead to a rally concentrated in shorter maturities, as investors remain cautious about election risk and the possibility of a hard landing.BofA also points out that the upcoming CPI report will be important for gauging market sentiment toward the Fed’s November meeting.While the market currently assigns a 16% chance of the Fed holding rates steady in November, the bank does not expect a single month’s data to drastically alter the Fed’s policy direction.“Even after the strong payrolls report, Fed speakers still indicate a bias for additional cuts, and it would be very unlikely in our view for the Fed to adjust the direction of policy from one month’s data,” strategists continued.In terms of broader market sentiment, BofA remains neutral on breakevens (BEs), pointing out that recent rallies have been driven by improving risk sentiment and rising oil prices. However, it remains skeptical about the sustainability of these drivers, particularly as their equities team forecasts a year-end S&P 500 level below current prices.Further increases in oil prices, they believe, will depend on geopolitical developments in the Middle East. More

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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.At the end of September there was a big spike in the Secured Overnight Financing Rate. This may already be putting you to sleep but it’s potentially a big deal, so please stick around. SOFR was created to replace Libor (R.I.P.). It measures the cost of borrowing cash overnight, collateralised with US Treasuries, using actual transactions as opposed to Libor’s more manipulation-prone vibes. You can think of it as a proxy of how tight money is at any given time.Here you can see how SOFR generally traded around the central point of the Federal Reserve’s interest rate corridor, and fell when the Fed cut rates by 50 basis points in September. But on the last day of the month, it suddenly spiked. This is natural, to an extent. There’s often a bit of money tightness around the end of the quarters, and especially the end of the year, as banks are keen to look as lean as possible heading into reporting dates. So SOFR (and other measures of funding costs) will often spike a little around then.But this was FAR bigger than normal. Here is the same chart but showing the end-of-2023 spike, and little dimples at the end of the first and second quarters.Indeed, Bank of America’s Mark Cabana estimates that this was the single-biggest SOFR spike since Covid-19 wracked markets in early 2020, and points out it happened on record trading volumes.Cabana says he was initially too hasty in dismissing the spike as driven by a short-term collateral shortage and unusually large amounts of window-dressing by banks. In a note published yesterday, he admits to overlooking something potentially more ominous: reserves seeping out of the banking system.We have long believed funding markets are determined by 3 key fundamentals: cash, collateral, & dealer sheet capacity. We attributed last week’s funding spike to the latter 2 factors. We overlooked extent of cash drain in contributing to the pressure. The increased sensitivity of cash to SOFR hints of LCLOR. LCLOR stands for “lowest comfortable level of reserves”, and might require a bit more explanation.Back in ye olde times (pre 2008), the Fed set rates by managing the amount of reserves sloshing around the US monetary system. But since 2008 that has been impossible due to the amount of money pumped in through various quantitative easing programmes. That has forced the Fed to use new tools — like interest on overnight reserves — to manage rates in what economists call the “abundant reserve regime”.But the Fed has now been engaging in reverse-QE — or “quantitative tightening” — by shrinking its balance sheet sharply since 2022. The goal is not to get the balance sheet back to pre-2008 levels. The US economy and financial system is far larger than it was then, and the new monetary tools have worked well.The Fed just wants to get from an “abundant” reserve regime to an “ample” or “comfortable” one. The problem is that no one really knows exactly when that happens. As Cabana writes (with FT Alphaville’s emphasis in bold below): Like the macro neutral rate, LCLOR is only observed near to or after it is reached. We have long believed LCLOR is around $3-3.25tn given (1) bank willingness to compete for large time deposits (2) reserve / GDP metrics. Recent funding vol supports this.A similar dynamic was seen in ‘19. At that time, the correlation of changes in reserves to SOFR-IORB turned similarly negative. The sensitivity of SOFR to reserves correlation signalled nearing LCLOR. We sense a similar dynamic is present today.Unfortunately, when reserve levels drop to uncomfortable levels, we tend to find out very quickly, in unpleasant ways.Cabana’s mention of 2019 is a reference to a repo market crisis in September that year, when the Fed missed growing hints of tightness in money markets. Eventually it forced the Federal Reserve to inject billions of dollars back into the system to prevent a broader calamity. MainFT wrote a superb explainer of the event, which you can read here.In other words, the recent SOFR spike could be a hint that we are approaching or already in uncomfortable reserve levels, which could cause a repeat of the September 2019 repo ructions if the Fed doesn’t act preemptively to soothe stresses. Here are Cabana’s conclusions (his emphasis):Repo is heart of markets. EKG measures heart rate & rhythm. Repo EKG flags shift. Cash drain has supported spike in repo. Fed should take repo pulse & sense shift. If Fed too late to diagnose, ‘19 repeat. Bottom line: stay short spreads w/Fed behind on diagnosis. More

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WASHINGTON (Reuters) – Republican presidential candidate Donald Trump has pledged to lower taxes on U.S. citizens living abroad, in his latest attempt to lure voters before the Nov. 5 election in which he is locked in a tight race with Democratic Vice President Kamala Harris.WHY IT’S IMPORTANTBoth Trump and Harris have in recent weeks made economic pledges to woo voters. Harris has said she will aim to pass a middle class tax cut, while Trump has advocated cutting taxes on overtime pay. Both candidates have supported eliminating taxes on tips.KEY QUOTE”I support ending the double taxation of overseas Americans,” Trump said in a statement from his campaign. The Wall Street Journal was the first to report Trump’s plans. The statement offered no specific details on how he would go about this policy.CONTEXTAmericans living or traveling outside the United States are required to file income tax returns, estate tax returns, and gift tax returns and “pay estimated tax in the same way as those residing in the United States,” according to the U.S. Internal Revenue Service.The U.S. has tax treaties with a number of foreign countries that already allow reduced rates and exemptions. Americans abroad do not have to pay U.S. taxes on their first $126,500 in earned income and are eligible for some foreign tax credits, according to the IRS.Claiming the foreign tax credit can let individuals effectively reduce their U.S. tax liability and avoid double taxation on the same income earned internationally.BY THE NUMBERSAbout 4.4 million U.S. citizens lived abroad as of 2022, according to data from the Federal Voting Assistance Program. About 2.8 million of those were eligible to vote in their former states. More

The People’s Bank of China (PBOC) said eligible securities firms, fund companies and insurers can apply to join the swap scheme, which gives them easier access to funding to buy stocks.The announcement came after Chinese stocks tumbled on Wednesday following a blistering rally, as previous investor enthusiasm about Beijing’s plans to revive the economy waned.The PBOC first announced the scheme on Sept. 24 as part of a broad package of policies to stimulate the economy and boost capital markets.Under the swap facility, eligible securities firms, fund companies and insurers can use their assets including bonds, stock ETFs and holdings in constituents of the CSI 300 Index as collateral in exchange for highly liquid assets such as treasury bonds and central bank bills. The initial scale of the swap program is set at 500 billion yuan, and can be expanded in the future. ($1 = 7.0800 Chinese yuan) More