Now that the balance sheet reduction is in swing, I haven't really seen very much written about it.




We are accelerating the payback. The wind down of this balance sheet should be pretty telling.
Past year:



I get the sense that we (as a country) don't know as much about inflation, quantitative easing as we would have everyone believe.

Quote:

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"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design".
- Friedrich Hayek

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It seems the equity markets are still flush with capital and the Fed still has firm control over short term interest rates. If anyone sees signs of an impact, please post here.

• If QE provided massive support to growth and jobs during the downturn, surely its withdrawal will create some drag on the economy's performance. Do we see any signs of this?
• What will the reduction in liquidity imply for credit markets for business and consumer lending? In theory, +$2.5 trillion greenbacks are getting sucked out of circulation.
• Is the Fed's purchase of longer term treasuries and MBS (pushing longer term rates up) preventing the yield curve from inverting?
• Historically many believe that the Fed itself has caused several recessions by tampering with interest rates and liquidity. Will they trip up the economy this time?
• I currently own more 2 year treasuries (in the form of a fund) than I have ever owned. Will retail and institutional investors be moving out along the yield curve as longer term interest rates increase (again reducing the demand for longer term securities)?

I personally don't think that QE had that much inflationary or growth impact, and I wouldn't be surprised if the reduction in the Fed balance sheet has little impact as well. Still, I want to be vigilant.

Rising interest rates plus taking $40 billion a month out of the economy for QE payback reduces liquidity. Yes, it's having an effect. So far the forward PE of the S&P 500 has dropped about 2 points or almost 12% from 17+ to 15+.

Also with rates going up, investors can get some yield on T-Bills and T-Bonds without risk. Frankly a 3% yield on the 10 year isn't atttractive to me, but in a year that 3% yield will be a 4% riskless yield and that's going to attract some money away from the stock market.

So in summary, taking $4 trillion out of our economy is going to have effects and I believe with less money chasing stocks, it's going to contract PE's, making borrowing more expensive and increase borrowing costs and reduce profitability for highly leveraged companies and individuals.

But this is a first so nobody is a real authority/veteran having seen this movie before and I'm not pretending to be one.... just giving you my obervations and thoughts.

I am pretty sure they have been unwinding for almost a year now. There has been a lot of talk before and after that it would lead to a crash, but most of that talk has stopped. I guess it has stopped because it isn't having the effect like they thought.

I am under the belief that adding to the balance sheet didn't help anything. The stock market rebelled when the QE was announced. The stock market immediately recovered when mark-to-market was reinstated. Also, the reserves just sat there. Banks wouldn't lend it out. Either people were too scared (banks included) or wanted to repair their balance sheets. Banks increased their lending standards. If the reserves didn't do much being built up, it won't do much coming back out.

That doesn't mean the FED wont' mess it up, which is a valid concern with their history.

It will be interesting to see what happens going forward. PFO mentioned contraction. I agree. However, will people still be dumb like they have been historically? Turn down 5-7% long term bonds because rates are going to keep going up and they can lock in better rates by waiting or because the market has been on a tear and makes 15%/yr, which beats 7%.

nm

hope the Fed's unwind isn't being done by an algorithm. Fed sells and starts a market drop. algorithm sees it and triggers to sell more putting more downward pressure on the market. lol

We can safely assume, if there is an algorithm, it won't be as you described.

Quote:

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It will be interesting to see what happens going forward. PFO mentioned contraction. I agree. However, will people still be dumb like they have been historically? Turn down 5-7% long term bonds because rates are going to keep going up and they can lock in better rates by waiting or because the market has been on a tear and makes 15%/yr, which beats 7%.

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I didn't see you mention anything about bond duration.

I'll be one of the dumb ones and turn down 5-7% long term bonds because the duration will be 7 years or better, as of this writing. I would not buy, nor hold, those bonds in a rising interest rate environment. I'd take my chance in equities under that scenario.

AgBank said:

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We can safely assume, if there is an algorithm, it won't be as you described.

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it's a joke

Long term is long duration.

I am referring to a few times in history when safe rates were 5 - 7+%, and everyone was convinced rates were going higher. Rarely did that happen.

I do believe you are wise in this current environment, especially when the Fed has told us they are raising rates. Once they are done saying it, and if safe rates are at 5%, it would be wise to consider safe bonds for a portion of your portfolio.

Fed announced that they may slow the balance sheet reduction in Sep.

We are now below the $4 trillion mark.

pfo said:

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Rising interest rates plus taking $40 billion a month out of the economy for QE payback reduces liquidity. Yes, it's having an effect. So far the forward PE of the S&P 500 has dropped about 2 points or almost 12% from 17+ to 15+.

Also with rates going up, investors can get some yield on T-Bills and T-Bonds without risk. Frankly a 3% yield on the 10 year isn't atttractive to me, but in a year that 3% yield will be a 4% riskless yield and that's going to attract some money away from the stock market.

So in summary, taking $4 trillion out of our economy is going to have effects and I believe with less money chasing stocks, it's going to contract PE's, making borrowing more expensive and increase borrowing costs and reduce profitability for highly leveraged companies and individuals.

But this is a first so nobody is a real authority/veteran having seen this movie before and I'm not pretending to be one.... just giving you my obervations and thoughts.

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This was very clearly written for someone like me. With the recent $200 billion injection into the economy the last three days, any ideas as to what is coming next?

I m not sure it is $200bn. I don't know the repo market, but I don't think you can add the 3 nights together. Does the repo market turn over nearly every night?

Sad I just found this thread. Really great to read your thoughts from the beginning. Your intuition was perking at the right time!

Are you in finance for a living?

Do you think we kickoff the next wave of QE here? Hard to believe market still falls for it. Would also be curious to hear what your portfolio looks like on a basic level.

https://news.yahoo.com/ny-fed-pump-75-bn-money-markets-daily-154943871.html

$75 billion daily until 10/10....

I was an investment banker in a prior life.


I don't purport to understand liquidity or have a deep understanding of repo markets. I believe there are some sharp people on TexAgs who have pointed out things that I haven't thought of before.

A book that I really like is called Lords of Finance by Liaquat Ahamed (I recommend it to anyone who likes the history of the Fed). One thing that I came away with is that providing short term liquidity to the market is something the fed has always done.

I am just going to add a little update.


It is too early to judge the rate of balance sheet increase, but I doubt it will take us long to his 4 trillion. December 2019, Jan 2020 perhaps?

To be honest, I'd put money that there is less than 100 people on the planet that can truly describe how central banks mechanically interact with the public markets.

I remember David Tepper being interviewed on CNBC, and they had their talking points over US earnings. He goes into how there was some Fed change that was affecting equity inflows more than earnings. Then, it just got awkwardly quiet for about 5 seconds.

Another 105 billion into the banking system today via repo market. The Fed has stated multiple times that they will be accommodating to the markets. Trump has called for interest rates to be 0 or even negative with some quantitative easing thrown into the mix. The next 12 months should be rather interesting. One thing is for certain... we will never see normalized rates ever again.

It comes down to inflation. If inflation is not an issue, rates will likely not go up.

Quote:

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"does not expect the federal funds rateto rise back to its long term average of around 4% in [his] lifetime

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A quote by Bernanke while at private dinners according to Reuters.

Is most of this being driven by the deficit? Since we are issuing more bonds, free cash isn't available, so the Fed is stepping in to provide the cash on a short term basis?

~egon

Dr. Doctor said:

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Is most of this being driven by the deficit? Since we are issuing more bonds, free cash isn't available, so the Fed is stepping in to provide the cash on a short term basis?
That is sort of a tricky question.

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We likely wouldn't have this problem if we didn't have a deficit. You could say that the liquidity mismatch in supply and demand could be brought about b/c it is the end of the quarter cash needs and our creditors have their own issues (e.g., Saudi Arabia likely isn't buying treasuries right now).

I guess it reminds me of the Hemingway quote on how you go bankrupt:

"Two ways, Gradually and then suddenly."

Certainly the increase in the size of our deficit is adding to the long term problem, but that is not likely the major reason for the timing of this issue.

It's on its way to 8-10 trillion easy. The new stimulus package that is trying to get passed in the senate is an additional 6 trillion. Also add the Fed being in official unlimited QE... it's about to skyrocket! But the economy is fine! Nothing to see here. Go about your daily lives.

Outdoorag011 said:

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It's on its way to 8-10 trillion easy.

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Agreed. When should I start thinking about the long term risk of inflation?

What are public alternatives to buying gold? REITS?

THERE IT IS:

The taper begins

*FED SAYS TAPER STARTING NOVEMBER, MONTHLY REDUCTIONS OF $15B

— Joe Weisenthal (@TheStalwart) November 3, 2021

Here we go again.

Outdoorag011 said:

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It's on its way to 8-10 trillion easy. The new stimulus package that is trying to get passed in the senate is an additional 6 trillion. Also add the Fed being in official unlimited QE... it's about to skyrocket! But the economy is fine! Nothing to see here. Go about your daily lives.

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.... And 8.5 Trillion was correct (for now). Good Job Outdoorag011!