No one is saying it, but there have to be plenty of people at the Fed questioning whether these conditions can ever be normalized, at least in the sense that term was understood when the first QE programs were rolled out as temporary, emergency measures. The financial markets rolled over big time last December and the real economy has battled a slowdown all year that could still wind up as the first recession in over a decade. They basically tried to normalize interest rates and their balance sheet and the effort failed miserably. The reason this is arguably worse than before is the Fed isn’t playing around with assurances of normalization and payback anymore. At the stated rate of buying ($60b/mo.), the Fed’s balance sheet will be bigger than ever before by the time the current planned purchases conclude by mid-2020. Unfortunately, as the chart also shows, the Fed has reversed 40% of that progress in just the past two months. As the chart below shows, the Fed spent 21 months slowly reducing the size of their balance sheet, unwinding those prior QE purchases. And, in fact, they did try to follow through on those assurances. First, in all the prior versions of QE the Fed was explicit that their monetizing of the Federal Debt issuance was temporary and the intent was that such buying would eventually be unwound in the future. Thus the ironic "not QE" mentions here in this post and throughout the financial media. The only difference in terms of what the Fed is doing now versus several years ago when it was QE is they’re buying shorter-term debt now (T-Bills) whereas they were buying longer-term debt (T-Bonds, among other types of debt) then. But from a "tell the truth!" perspective, this is pretty simple. This time, they’ve tried to be clear that this new effort isn’t QE. When the Fed was buying new Treasury debt earlier in the decade, they called it Quantitative Easing, or QE for short. So the Fed has stepped back into the picture as an immediate buyer of this new debt. Translation: the mechanism to place new Treasury debt was breaking down because there is now so much of it being generated. They subsequently, and much more quietly, announced two additional Repo operations targeting longer (up to 14-day and up to 28-day) periods. On October 8, they upped the ante by announcing they would begin buying $60 billion of short-term Treasury Bills each month through the middle of 2020. You may have heard that we’re issuing a lot of new debt? Well, the fact that foreigners aren’t gobbling it up as rapidly as in the past means that domestic sources are having to absorb more, even as the amount issued soars.įurther simplifying a complicated story, the Fed first stepped in with overnight operations to help the Repo market. This article by Lyn Alden Schwartzer does a great job of breaking down the backstory, but the short version is that it appears that the banks that serve as the conduit of placing new Treasury debt were getting overwhelmed by the rate of issuance by the Federal Government. For reasons that were largely unclear at the time (and are admittedly still opaque but getting clearer), banks weren’t lending to each other at normal, low-risk rates. What changed the market’s trendīack in September, we noted the strange problems occurring in the Repo - or overnight bank lending - market. But as we’ll see, there are still some issues to consider - especially for investors nearing or already in retirement. Thankfully, the SMI strategies are equipped to handle this. I’m going to briefly explain what has happened over the past two months, its impact on the financial markets and the current market trend, and what our response should be as SMI investors. To no one’s surprise, the Fed is at the center of the shift in market trend. Importantly, there was a clear catalyst to this change, one with enough of a track record to plausibly suggest it could keep stocks moving higher for a while longer. Stocks have posted six straight weeks of higher prices, pushing the S&P 500 Index above its long-term trend-line and breaking through the pattern of the past two years where significant new highs were inevitably met within the next few weeks by a market pull-back or correction.
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