Thursday, May 5, 2022

Fed To Tighten - How Will It Impact Stocks?

Yesterday the Fed announced at 50 bp interest rate increase and the start of a monthly reduction of its balance sheet - ie quantitative tightening (QT).  I strongly believe that QT is far more important and impactful for markets than raising rates.  It will drain liquidity, the very oxygen of markets that today are highly dependent on plentiful and cheap liquidity to "carry" financial assets on borrowed money.

The following chart makes things clear: notice how in 2020 the stock market (red line) soared at exactly the same time as the Fed pumped its balance sheet to record highs (blue line).   Pandemic fears made no difference: the torrent of money raised equity prices, regardless.

Is it now time for a reversal? I think so, depending on how committed the Fed is on killing the inflation itself has brought upon us all by the self same money torrent.  Again, I don't think the Ukraine-Russia war has any real significance in all of this.. it's all about money.  Predictably, share prices have eased off their highs well in advance, discounting the Fed's actions.

The only remaining question, therefore, is how tight will the Fed get?  Again, in my opinion, it won't ease off any time soon;  the process will drag on, possibly for years instead of months.


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  2. thinking at a slightly different tangent... the Feds job is to balance employment vs inflation. From a monetarist point of view, if total employment derived income goes up, inflation must go up; and vice versa. Thus, the only way to balance employment and inflation is to have employment income remain static (or even declining) but divided among more people. Sounds like the economy we have eh? More and more low wage jobs; (until recently) low inflation.

    The key to taming inflation is to keep money out of the hands of the hoi polloi, 100% income tax anybody?... If we did that, we could keep interest rates at zero... joking a bit... but I think that is the cost function right now. =)