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Daily Reports 17

Equities up; dollar down

By David Morrison  |  25/01/2019 16:01

Traders rushed to buy equities while dumping the dollar on hopes of renewed US-Chinese trade talks and rumours that the Fed is considering winding down its balance sheet reduction programme

/>The dollar fell sharply on Friday afternoon while US and European stock indices (absent the UK’s FTSE100) soared as investors recovered their risk appetite ahead of the weekend. There were a couple of positive stories doing the rounds. Firstly, there was confirmation that two senior Chinese ministers would be going to Washington next week to pave the way for a visit from China’s top trade negotiator, Liu He. This helped to put a spring in the step of investors following some downbeat comments yesterday from Commerce Secretary Wilbur Ross. Mr Ross had said that the US and China were still ‘miles and miles’ from any kind of trade deal, although he subsequently added that this shouldn’t be a surprise to anyone given the complexity of such talks.

There was some additional excitement following speculation in the Wall Street Journal that the Federal Reserve may be closer to ending its balance sheet reduction programme sooner than previously anticipated. While members of the Fed have been understandably coy about what the ideal size of the balance sheet should be, it was abundantly clear that it should be significantly below $4.5 trillion, although it wouldn’t get anywhere near the pre-financial crisis level of sub-$1 trillion. Nevertheless, putting together some timeline estimates (with Jerome Powell suggesting an end-date between 2020 and 2021) then a reasonable guesstimate could bring the ‘resting’ balance sheet down to, say, anything between $2.6 and $3.0 trillion*.

Well it now seems that the Fed may be prepared to tolerate a bigger balance sheet which suggests either a slower rate of balance sheet run-off or ending the programme sooner than expected. Either way, this looks like an admission that the Fed now views the balance sheet reduction programme as an important driver of asset prices having previously suggested it was of little consequence.

*Current balance sheet: $4 trillion – then around $40 billion reduction per month for two and a half years
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