01/11/24 09:25 AM EST

Fed Balance Sheet Reduction Dynamics

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.

The chart depicts the Federal Reserve's balance sheet expansion and contraction alongside the NYSE index. The bars represent periods of quantitative easing (green) and tightening (red), while the line indicates the NYSE's performance.

The Federal Reserve has reduced its balance sheet by approximately $1.5 trillion in the past 18 months and aims to reduce it by $5 trillion over the next 10 years, which is good. Secretary Yellen, on the other hand, is putting the G in GDP, but we have spoken about government spending ad nauseam. Despite this tightening, market expectations are leaning toward interest rate cuts, with speculations in December Fed fund futures pointing towards 6 to 7 cuts, which seems improbable. Yes, 6! Such a high number of cuts would likely only occur in a scenario where the market is under severe stress or "crashing."

The current 250 basis point gap between the Fed funds rate and inflation suggests that some rate cuts are anticipated to bring interest rates more in line with inflation, which would be a standard policy move to normalize rates. This isn't considered a radical approach but rather a response to economic conditions as the Fed seeks to balance its dual mandate of controlling inflation and fostering employment. The wild card here is we are talking about the Fed in a proactive, not reactive, sense. The Fed is filled with incredibly intelligent and talented people but is not known for being necessarily proactive.

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