Get 40% Off
🤯 This Tech Portfolio is up 29% YTD! Join Now to Get April’s Top PicksGet The Picks – Just 99 USD

It's the Fed's Balance Sheet, Stupid

Published 01/22/2019, 11:36 AM
Updated 01/22/2019, 01:09 PM
© Reuters.

© Reuters.

The key to get an indication of the Fed’s true monetary policy stance is to keep your eye on the Fed balance sheet, writes Landon Whaley. He's presenting at MoneyShow Orlando Feb. 9.

Investors are paying attention to the wrong aspect of Federal Reserve policy. I’ve seen enough Fed soundbites from both hawks and doves over the last few weeks to last me a lifetime. However, as is usually the case, people are focused on the wrong aspect of monetary policy, and their pre-occupation with rate hikes (and cuts) is going to get them the same woodshed treatment they experienced in Q4 2018.

Pre-crisis, the most important aspect of central bank policy was probably the action a central bank took with short term rates. But it’s 2019, and after a decade of unprecedented easing by central banks globally, the most important aspect of monetary policy is the balance sheet and how central banks manage it.

Back in November, we highlighted the fact that the Bank of Japan’s balance sheet had just surpassed the nominal GDP for the entire Japanese economy. This marked the first time in history that a central bank’s balance sheet had surpassed the GDP of the economy where the central bank resides.

But it’s not just the Bank of Japan buying up everything that isn’t nailed down. Over the last decade, the four major central banks involved in QE (U.S. Fed, ECB, BOJ and BOE) have expanded their balance sheets by nearly $11.3 trillion through various asset purchase programs.

The $64,000 question we posed back in November was, “What happens to financial markets when four of the primary buyers stop spending money like a sailor on weekend leave?”

Well, the Fed has already given us a little taste of the impact that a balance sheet reduction can have on financial markets. Over the last 12 months, the Fed has reduced its total balance sheet by approximately 7% from its October 2017 peak. In the grand scheme of things, 7% is a thimble-size reduction in liquidity, yet look at the 2018 havoc that balance sheet reduction had on emerging market economies and then ensuing crashes across emerging market currencies and equities markets.

As 2019 is getting started, everyone is trying to predict what the Fed will or will not do.

Despite all the ink spilled and airtime filled with commentary on Fed policy, no one is discussing the fact that just because the Fed stops raising rates, doesn’t mean it’s stopped tightening.

The $50 billion in bonds the Fed is currently allowing to “roll off” its balance sheet each month carries the same tightening consequences as if it actively raised rates by 0.25% every four months.

This math tells us that regardless of what they say or do, as long as the balance sheet reduction remains in place, then we are getting three rate hikes in 2019.

Let other investors splice and dice every word uttered by Fed presidents from Kansas City to Chicago and then whipsaw their portfolio based on whether those soundbites are dovish or hawkish. The key to get an indication of the Fed’s true monetary policy stance is to keep your eye on the Fed balance sheet.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.