The long and unwinding road
Anyone following my work over the past couple years is familiar with my analysis regarding asset price levels and the central bank asset purchase or quantitative easing (QE) programs. The bottom line was that as long as QE remained in place at a high enough level the upward momentum of asset prices could be maintained.
Of course, price levels depended on the amount of QE stimulus and its effect on the US sovereign debt yield curve. If the US Fed, either working alone or with the cooperation of the other major central banks was able to provide enough “demand” prices could be enhanced on a broad range of assets. These assets included equities, bonds, commercial real estate, artwork, residential housing, and even cryptocurrencies and bitcoin.
This is why I was bullish on asset prices of all kinds; we cannot overcome trillions in official stimulus. This can can change, of course, if that stimulus ends or declines to the point that the lofty price levels cannot be held up.
The water draining out of the tub is more than what’s coming out of the faucet
The monetary stimulus is like a bathtub filling up with water while the drain is open. If the water coming out of the faucet is high enough the tub will continue to fill regardless of the open drain. If the incoming water volume drops then the water level will start to fall. The QE’s effect on the markets work the same way.
Fiscal policy, such as government spending and tax cuts, can indeed provide a support to prices, but monetary policy is always needed to be congruent with the fiscal stimulus. If the agenda of the Fed contradicts with fiscal policy the best we could get is a Mexican standoff, where the markets will fumble and most likely fade.
We have been warned
I have attached the results of the latest release of the US Fed’s balance sheet changes from March 29th. As you can see the Fed continues to unwind its balance sheet at a consistent rate. Indeed, the long unwinding has been occurring since last October. Under the schedule for 2018, the Fed’s Treasury holdings will be reduced by $270 billion while holdings of mortgage-backed securities will be reduced by $180 billion. This means that $450 billion will be sold out to the market place in one way or the other by the end of this year; with about $500 billion being removed from the Fed balance sheet in total by the end of the year, since last October.
This is quite a bit of money for the markets to absorb and as we can see that despite all of the Trump regime’s front-loaded market stimulus, the markets are continuing to stumble. The higher volatility is just the shape of things to come and we need to get used to it. So, it should not come as a shock to see stocks struggle and cryptocurrencies go down for the dirt nap. If anything, the performance of bitcoin should be a warning to all that the central bank monetary agenda still controls all assets. Bitcoin is not ready for prime time.
We cannot rely on the European Central Bank to hold up the fort, as it is desperately trying to keep the EU together and the weak PIIGS nations on life support. The Bank of Japan is trying to keep its national economic zombie from imploding.
Recall all my analysis on the cryptic statements from the monetary policy puppets. We can even consider that short of nuclear war, the current Fed Chair, Jerome Powell, has repeatedly stated that the Fed is going to continue this long unwind. As you can see above with the numbers provided by the Fed a couple days ago the plan is going according to schedule.
In other words, the monetary policy mouthpieces are warning us. I am listening and responding accordingly. I hope you are doing the same.
So, look at all this market turmoil from the sidelines. If it will take a virtual catastrophe to halt the Fed’s plans then I have to continue to say that cash is king.