• Bull.




Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

We decided to check in and see how the Fed is doing with its QT program. We are not the FOMC authority; we would direct you to a discussion between our own ProfPlum and Danielle DiMartino Booth, which can be found here. They discuss the current state of the Fed, the economy, and the successes and failures of QE and now QT. It’s A+ content and research from Danielle. Be warned you may need a stiff drink on hand.

What Happens When the Gap Between Fed Liquidity and S&P Closes? - 10.19

The Fed has been able to reduce the size of the balance sheet by a trillion dollars since April of 2022, leaving them with a minuscule $8 trillion. That barely buys a banana in today's inflationary economy. Today’s bonus chart illustrates that we still maintain one of the biggest correlation gaps between S&P 500 and Fed liquidity. Implicitly, the gap closing takes S&P 500 well below 4200 short-term.

Incentives for the Fed to keep reducing the balance sheet are three-fold.

  • The Federal Reserve, once operating with a lean balance sheet primarily tied to non-interest incurring currency, is now vulnerable to losses, especially if interest rates rise rapidly during tightening cycles. While the Fed can't go bankrupt due to its ability to create reserves, prolonged losses might necessitate Treasury support, inviting political scrutiny.
  • The composition of the Fed's assets also supports the idea of reducing the balance sheet. Presently, the Fed holds $2.7 trillion in MBS. Its January-released plan showcased an inclination to primarily possess Treasuries. Purchasing non-Treasuries impacts credit allocation across economic sectors, and many believe such decisions should be Congress's or the Treasury Department's prerogative, not the Fed's. Achieving a Treasuries-only balance sheet might be challenging, especially with rising mortgage rates reducing MBS maturation. It’s been suggested the Fed could expedite this by actively selling some of its MBS, but this will also increase the risk of losses.
  • A final reason for engaging in QT is to free up capacity for a future QE. If the Fed's balance sheet were to continue to grow, it could, in theory, run out of Treasuries or other acceptable assets to purchase to conduct QE in the future.

Learn more about the Market Situation Report written by Tier 1 Alpha.

What Happens When the Gap Between Fed Liquidity and S&P Closes? - HISbanner

What Happens When the Gap Between Fed Liquidity and S&P Closes? - marketsituation


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