🏛 Nordea's Fed Watch

• Directional surprises to the upside (even if they are material) hence do not influence market pricing to any large extent as both the market and the Fed will label it a transitory price increase, why the only thing that matters now is whether inflation levels prove sustained or not.

• The next phase could prove even more interesting as our models suggest that the rent of shelter component prints at 3.75%-4.00% by late summer, which will lead to core inflation remaining clearly above 3% all the way into 2022. It will be much tougher to explain a price increase in the rent of shelter away as a short-term bottle-neck but this is likely a story for the early autumn or thereabout.

• So, what will actually happen on Wednesday in our view?

First, the updated dot plot may hint of one hike in 2023 as very few members of the FOMC will have to change their mind in a positive direction for that to happen.

Second, the Fed will have to address the ongoing surge in the ON RRP facility (547bn $ as of Friday), which is a side-effect of the liquidity flood seen due to continued QE and the drawdown of the Treasury General Account. The NY Desk is likely to suggest a few technical changes to the policy framework to ensure continued smooth operations.

Interest on excess reserves hiked by 5bps

Counterparty caps likely be widened further in the ON RRP

• The ON RRP has recently swallowed all of the USD liquidity additions from other channels – effectively leaving excess liquidity roughly unchanged. This also limits the effect of further QE from the Fed and eventually it is likely to play a role in an upcoming tapering decision (we expect a decision in September) since the QE program is currently stuck in a circular error mode, at least if the Fed remains firm that they don't want sub-zero price action in USD funding markets

• We also find the scope for a swift tapering process better in the US compared to the Euro area, why we find good value in shorting EUR/USD towards the year-end. The already “peaking” USD liquidity should also lead to a repricing of the EURUSD xCcy basis towards a more expensive USD.