Equity markets are in full correction mode, politesse for dropping like a stone. They are discounting the Fed’s recent and future monetary tightening measures - most of which haven’t even started yet. Specifically, the Fed will commence Quantitative Tightening, ie the reduction of money supply by shrinking its balance sheet. Starting in a few days, the Fed will begin selling bonds from its portfolio in the open market to the tune of an estimated $90 billion per month. The result? What went up, will go down: pump and jump turns into stop and drop, see chart below.
Saturday, May 21, 2022
It’s Just The Beginning
The question in everyone’s mind is, has this drop fully discounted the Fed’s upcoming actions? In my opinion, not by a long shot - as the title says, it’s just the beginning.
Because the Fed is - finally! - committed to combatting soaring inflation, the very inflation it created all by itself by vastly expanding its balance sheet (ie creating new money) from $4 trillion to $9 trillion. And the ONLY way to lower inflation this time is to give it a one-two punch: raise interest rates and decrease money supply. Make money more expensive and make it scarce.
Unlike inflation in the 1970s and 1980s which was brought about mainly by exogenous oil price shocks, today’s inflation is purely a domestic monetary phenomenon. It cannot be dealt with by raising energy efficiency, turning down the thermostat or wearing a sweater indoors (who remembers Jimmy Carter’s cardigan?). This time, it must be dealt with in monetary fashion.
My guess is that the Fed and its goofy cousin the ECB will draw this out unnecessarily, instead of going for a knockout punch - they are just not decisive or brave enough, and they are much too beholden to the financial-investment community. So, this will go on for a long while and inflation will persist.
My working model is for years, not months, of restrictive monetary policy and a long-lasting bear market in equities instead of a big “crash” followed by a sharp rebound. This is going to be with us for much, much longer than Wall Street expects.