• Things can get messy in the next two months
• QT and decline in TGA are becoming more acute
• Repo facility can help to offset some negatives

It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.

George Soros

Over the last decade, the holy grail for keeping performance statistics in good shape was establishing a clear view of the FED’s actions and their effect on global liquidity. Even some brutal mistakes in the valuation process were not so important in determining the soundness of the investment strategy. The only thing that matters is whether you are on the right side of unprecedented liquidity injections.

While there have been some ups and downs in the global economic cycle, this relationship has not yet broken. Many sophisticated macro strategists still deploy all their resources to conclude whether the market will operate under tight or loose financial conditions. Forecasting the medium to long-term growth and inflation dynamics is one of the core elements of building a solid ground for comprehending the direction of the monetary policy. But to have a complete picture, all the ingredients that constitute the right measured policy action should be observable through the lens of end policy goals – stable prices and full employment. You can be sure that any deviation from those two primary targets will be met with fierce monetary discipline.

The recent record rise in inflation is probably one of the unforeseeable risks for those who started their career during a push for globalization, which kept any inflationary pressures at bay. No one could have imagined that we would ever operate at the Fed’s fund rate closer to 5%. But this is now a reality that no one wants to accept, as the pain for anyone exposed to risk assets torments even the strongest minds. How long this reality will last is still up for debate. In late 2022, there is no clear indication that we are even close to dissipating this reality into something more tolerable.

Considering the projected amounts of the Fed’s balance sheet deductions and the decrease in the Treasury General Account (TGA), the total effect on net liquidity is quite negative for the upcoming two months. On the other side, favorable seasonality and mid-term elections outcome are working to offset some of that damage, creating potential sideways action on the markets.

Investors should be careful in reading too much into the inflation peaking story, as it is rarely a case for inflation to meaningfully get back to a targeted level without a prolonged period of operating under a heavy tightening environment. We had only one-month data point, which is not enough to terminate the aggressive path we took to bring things to “normal”.

In our view, the upside in these conditions is limited until data for November and December confirms a more rapid decline in the inflation rate. Having very high sensitivity to any daily rhetorics of Fed speakers can force market participants to take too much risk. A more conservative approach until the end of this year is more beneficial from a risk management perspective.