wiley e coyote
And what’s the second thing you’re worried about?
Central bank liquidity has been an important factor driving the market. But now, the Federal Reserve is tightening. They have already tightened twice this year and they are talking about shrinking the balance sheet, starting in September. Also, the European Central Bank is talking about being less accommodative as well. So we’re going from a very accommodative monetary policy around the world to a more restrictive policy and that’s going to put a damper on the market.
Central bank liquidity has been an important factor driving the market. But now, the Federal Reserve is tightening. They have already tightened twice this year and they are talking about shrinking the balance sheet, starting in September. Also, the European Central Bank is talking about being less accommodative as well. So we’re going from a very accommodative monetary policy around the world to a more restrictive policy and that’s going to put a damper on the market.
But if monetary policy is getting less easy isn’t that also an encouraging sign that central bankers are having more confidence in the resilience of the economy?
The Federal Reserve has two mandates: low inflation and full employment. Right now we have full employment and low inflation. So the Federal Reserve is doing its job. They are achieving their mandate and the economy is not overheating. They have no reason to raise rates. But the Fed has allowed its balance sheet to growth significantly. Since the creation of the Federal Reserve it took 95 years to growth the balance sheet to $1 trillion. But because the banking system was in danger of melting down in 2008 they went to $2.5 trillion basically overnight and now they’re at $4.5 trillion. So the Fed feels guilty that it has expanded money too fast and they feel they have to shrink the balance sheet back.
The Federal Reserve has two mandates: low inflation and full employment. Right now we have full employment and low inflation. So the Federal Reserve is doing its job. They are achieving their mandate and the economy is not overheating. They have no reason to raise rates. But the Fed has allowed its balance sheet to growth significantly. Since the creation of the Federal Reserve it took 95 years to growth the balance sheet to $1 trillion. But because the banking system was in danger of melting down in 2008 they went to $2.5 trillion basically overnight and now they’re at $4.5 trillion. So the Fed feels guilty that it has expanded money too fast and they feel they have to shrink the balance sheet back.
What does that mean for the markets?
The Fed will shrink the balance sheet by letting the treasury bonds and the mortgage backed securities that are on its balance sheet mature and redeeming them. But that will take money out of the system and that’s very dangerous for the markets.
The Fed will shrink the balance sheet by letting the treasury bonds and the mortgage backed securities that are on its balance sheet mature and redeeming them. But that will take money out of the system and that’s very dangerous for the markets.
Why?
There is a significant congruence between the expansion of the Fed’s Balance sheet and the performance of the S&P 500. They are roughly congruent except for now because the market is running ahead of the Fed’s balance sheet. That makes me worried of a kind of Wile E. Coyote-Phenomenon where the market is running off the edge of the cliff and it doesn’t know it doesn’t have any land below it to support it. In this case, the missing ground would be the withdrawal of money from the system because not only is the Fed thinking about doing it but the European Central Bank is thinking about doing it as well. So naturally, the market is vulnerable to a 10% correction at any time.
There is a significant congruence between the expansion of the Fed’s Balance sheet and the performance of the S&P 500. They are roughly congruent except for now because the market is running ahead of the Fed’s balance sheet. That makes me worried of a kind of Wile E. Coyote-Phenomenon where the market is running off the edge of the cliff and it doesn’t know it doesn’t have any land below it to support it. In this case, the missing ground would be the withdrawal of money from the system because not only is the Fed thinking about doing it but the European Central Bank is thinking about doing it as well. So naturally, the market is vulnerable to a 10% correction at any time.
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