Thread by @MartingaleMacro

A brief discussion of how we are prepared for today's #FOMC minutes and Friday's #JacksonHole conference. 1/

First, know that #FOMC minutes are dramatically edited versions of transcripts so there is meaning beyond the last meeting. In the intermeeting period FINANCIAL CONDITIONS HAVE WEAKENED. 2/

There are a number of ways to measure this in USD terms, but they all point the same direction as high yield credit spreads, noted below, which are wider +50bps since July 31. 3/

Wider spreads = weaker conditions. Expect today's minutes to spend more text worrying about weaker financial conditions and using that as a implicit ex-post justification for July cuts and deeper cuts to come. 4/

If one takes that position to its logical extremis, as long as financial conditions weaken, the Fed must cut. And yet the credit cycle is deteriorating for reasons the Fed cannot "fix" readily. 5/

Similarly, if the Fed cannot fix, they will simply throw the only tool(s) they have at the problem over and over again until transmission from policy to the credit markets is successful. Rate cuts followed by QE possibly in short order. 6/

In summary, if today's #FOMC minutes do indeed focus on financial conditions, be prepared for EDZ0 to trend towards 99.75 through year end. 7/

How you choose to play it I will not advise upon, but that is 100 ticks of STIR upside theme even before #JacksonHole begins. 8/

Onto Jackson. It is quite clear that the risk is for Powell's speech to fall on the dovish side of expectations. There are many ways he could achieve that, but Jackson has historically been a venue to introduce new concepts.

What a pretty place. I prefer it in snow. 9/

Let the minutes do the talking on the rate trajectory and let the speech do the talking on new concepts. What is likely new here?
Two things are likely:

1) Methods of bull steepening the USD curve to fix Treasury funding problems.

2) Inflation targeting.

10/

On the former, there are a range of tools available. Adjusting the duration of portfolio reinvestment to favor bills is the easiest, so it will likely be tried first. A full allotment repo facility to ease funding pressures is an easy second. 11/

These two options would receive good reviews from the risk asset market and perhaps get the Trump monkey off of Powell's back for a time. Imperfect corollary, but in 2011, optwist was worth 7% to US equities.
12/

On the latter issue of import, inflation targeting, the Fed appears drifting towards 5yr inflation targeting regime. 13/

While rolling inflation targeting has merit, it will not be announced until after the major policy review from Clarida is complete (1Q 2020). The upshot is that it will ex-post justify 2019 rate cuts on an economic basis, not just a market one. 14/

A veneer of economic respectability is a good thing! 15/

By our estimate core PCE YoY will be running +2.1% at end of 1Q, but 5yr average core PCE YoY will be just +1.7%! 16/

In other words, if the Fed ultimately adopts 5yr inflation targeting, policy will officially be too tight in 1Q 2020, supporting the executed cuts and encouraging more cuts to stimulate inflation. 17/

There are threats to economic growth and credit cycle matters that line up unfavorably in 1Q 2020 as well. 18/

For now, the question is whether Powell will reference 5yr inflation targeting at his Jackson Hole speech. Our bet is that yes, he will do so, though in a Socratic not affirmative context, e.g., "longer term inflation targeting is a concept we are closely studying" 19/

We are positioned to take advantage of that theme in several ways, including 3y5y steepeners and OTM TY calls. While we are not max risk budget on these plays, and many are highly leveraged, they are substantial. 20/

This will be my last comment ahead of the Powell speech. There is sure to be a lot of fun had. As a former trading partner of mine in sellside days was fond of saying: you place your bets, you takes your chances.

Takk/