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S&P 500 Could Hit 3,500 By Year End

Published 09/09/2022, 09:34 AM
Updated 05/14/2017, 06:45 AM

“Don't fight the Fed” echoes through the financial media, Wall Street, and in the minds of retail and institutional investors. It pertains to Fed-generated liquidity and is often the sole basis for investors to chase bull markets when the Fed employs easy monetary policy. Unfortunately, some investors forget the phrase is equally meaningful when the Fed is not friendly to markets.

I have developed a model to track Fed liquidity, allowing us to quantify the Fed's influence on the S&P 500.

Before unveiling my liquidity formula and its forecast for the S&P 500, it's essential to discuss the three primary drivers by which the Fed is influencing liquidity: reverse repurchase (RRP), Treasury general account (TGA), and the Fed's balance sheet.

The New York Fed uses numerous repo programs to manage the supply of cash in the banking system, thereby maintaining the Fed funds rate within the FOMC's target range. It is employing its RRP program to accomplish this task. In an RRP transaction, the Fed sells securities to a counterparty and simultaneously agrees to repurchase them at a future date. The duration is often overnight. The transaction temporarily reduces the supply of money from the banking system. Increasing daily RRP balances results in less system liquidity, and a declining balance reduces liquidity.

As shown below, RRP has been around for 20 years but was scarcely used until early 2021. The various pandemic-related rounds of fiscal stimulus and massive Fed liquidity efforts left banks and money market funds with excessive levels of cash. The excess liquidity would have pushed the Fed funds rate lower than the target rate without the RRP program. As such, RRP sucks up liquidity, making Fed funds easier for the Fed to manage.

The Fed has other repo tools, such as repurchase agreements and the standing repo facility that can dampen money market rates by providing the banking system with liquidity.

Fed's Reverse repurchase Program

Use of the RRP facility has been increasing rapidly and now sits at over $2 trillion daily. Rising RRP balances are a drain on liquidity.

As money market yields rise with Fed funds and asset markets perform poorly, investors tend to prefer higher cash balances. Such should keep RRP levels elevated for the time being.

Treasury General Account (TGA)

The Treasury general account is the U.S. Treasury department's checking account. The account is held at the Federal Reserve Bank of New York. Like your checking account, the TGA receives deposits (tax receipts and proceeds from debt issuance) and makes payments.

The Fed doesn't manage the TGA balances, but the surplus cash balance held at the Fed affects banking system liquidity. Fed liabilities (bank reserves) must equal its assets. Bank reserves are fodder allowing banks to make loans and, by default, print money. When the TGA account increases, bank reserves must fall, reducing banking system liquidity. Conversely, a shrinking TGA account adds reserves and liquidity to the banking system.

The graph below shows that TGA balances are elevated versus the pre-pandemic years but have fallen as the banking system normalized from the massive fiscal cash injections. It will likely drop a bit more, but the TGA will not significantly impact liquidity, barring unusual circumstances.

TGA Account

Latest comments

Bias is always without exception for projecting a bullish scenario.  Car salesman never tell you to wait to buy.  Disinflation had a 40 year ingrained mindset and with it extreme exposure to assumed low risk low cost investments. No one thought we would ever be in an inflation environment lasting this long just 6 months ago and most believe disinflation will be with us forever.  ONLY the traders and analysts dating back to the 60's/70-'s would prepared for the possibility of sustained inflation pressures.  Wages, Job market and JOLTS report seal our fate for the next 6 months.  Can we ride the spike in inflation like the early 80's? Earnings projections suggest otherwise.  No one thought we could have the most corrupt inept narcissistic leader of the free world still retain popularity as the front runner of the GOP.  We live in a Matrix World of our own design without daring to see it for what it is. .Next 2 decades we swing the other way on the pendulum.
Thanks for the educational article @michel lebowitz. Are you planning a follow up detailing how your model predicticted $3500 for fed and by when?
are you talking about the Bidens and Pelosis?
are you talking about the Bidens and Pelosis?
are you talking about the Bidens and Pelosis?
1000 and Dow
1000 and Dow
1000 and Dow
S&P 500 and Dow Jones have already made the intermediate bottom, It's quite remote that Dow will break below the highs of 2020. The internals of Global Indices like India, Nikkei & FTSE has already signaled the end of a downtrend, Strength is emerging from new Sectors Lastly, Crude Oil is likely to remain in a Sweet Spot of between 75 & 95  To Summarize one can expect 4600 on S&P 500 by the year-end
having read this, I will short the SP500 even more.   SP500 will not reach new highs while the Fed (and ECB) are trying to slow growth via QT and rate hikes.     They will keep at slowing economies down until inflation is at 2%.  We're at 4x now.  September number for CPI likely to come in at 8.2%.   0.3% lower than last month but again 4x the Fed target.   You are welcome to drive up prices but you are overpaying for equities since growth will be compressed and earnings will be compressed.  Average SP500 multiple on earnings over a decade or so is 16x.  We're currently at 17x and your thesis is that under this fed and ECB tightening we're going to go to 18x.
Not buying what you're selling.
great! the lower it goes, the cheaper it gets. I'm buying all the way down every 2 weeks, stocking-up. let it fall while I accumulate.
The best minds in the business say it's gonna be worse than that. Dalio, Rickman, and many others.
michael burry
To all moon boys below: how many times we have already seen rallies this year and folks repeated to say this time a real bull cycle started and you were wrong at least 2 times this year. Short term relief rallies are common and one should not fight the trend, which is stilll strongly bearish
Almost every pundits have predicted a low 3000s for the S&P 500. I hope the market proves them wrong as the majority of the bets are skewing to the short side.
The market can prove them all wrong by tanking even more than what they expect and so they lose their shirts. There is no shortage of ways to lose money even if the analysts are correct about the trend.
It's all about inflation now. And next week we will probably see another drop, stronger than last one. That will be the signal for 4300, and maybe a 4500 by the end of year. Market is already oversold. If FED hike to 3.25 on 26 sept, there will not be much room to move higher. So the end of hike cycle is near, while inflation drop cycle is just at begging. There's no more clear buy signal than this one.
Inflation numbers will come up "better" than previous 9%, 8.5%, etc. But Powell let it clear that he won't be dissuaded by that because inflation doesn't go straight up all the time, but stops and resumes. He also said that aim is a stable 2% inflation, so we have a long way to go. The argument that if they go more hawkish sooner is somewhat bullish because they won't go as hawkish next is ilogical, the sooner a higher rate is set the sooner money will disappear from equities. Just imagine if they hiked all the way to 4% RIGHT NOW. Would that be bullish? No, so this argument is nuts.
We are talking about year over year inflation. If you tell me that 2022 August - 2023 August inflation will be higher than 2%, I don't believe it. Prices don't need to drop for that. Unfortunately, nothing ever will be cheaper.
Scientists "could" figure out time travel by year end. That doesn't mean it is going to happen. People like you that are so afraid of QT fail to realize that it will take 3 years to remove only 40% of the liquidity added during the pandemic and that is IF they keep doing it for 3 years which they won't
The bottom of this bear market could be as low as the 2400s given a 50% loss, which is not uncommon during a bear market.
Lmao ya good luck with that
You may as well make it easier to understand by predicting the market to be as low as 0. Good luck.
Just because the pundits are saying we are or will be in a recession that it will happen.
Forget it it will reach 5500
with Fed raising rates and QT, what is your thesis on reaching 5500?   you must have been one of those retail traders today buying up the market 2%
Oh no rates at 3.75% and a snail pace QT the market is doomed. Heading straight to 1000 spx... Here's a "thesis" for you. People never stop slamming money into the market every week. It comes right out of most people's check and fund managers have to invest it by law.
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