THE "LESSER OF TWO EVILS" IS FOR THE FED TO FACE THE NEXT DOWNTURN WITH RATES HAS FAR FROM ZERO AS MARKETS CAN WITHSTAND!



A PUBLIC SOURCED ARTICLE FOR MATASII (SUBSCRIBERS-RESEARCH & PUBLIC ACCESS ) READERS  REFERENCE

MACRO: US  - MONETARY POLICY

EXTRACTED FROM: 11-08-18 - RealInvestmentAdvice.com - "The Tailwinds To The Bull Market Have Shifted"



MATASII TAKEAWAYS:

  • It is likely one of following two conclusions is accurate:
    • The Fed is absolutely aware the economy is closer to the next recession than not. They also know that hiking interest rates in the current environment will likely accelerate the next downturn. However, the “lesser of two evils” is to face the recession with the Fed funds rate as far from zero as possible, or;
    • The Fed believes the economic data is indeed trending stronger and are overly confident in their ability to guide the U.S. economy into a “Goldilocks” type scenario where they can control inflationary pressures and growth rates to sustain a lasting economic cycle. 
  • With the Fed now on a rate hiking campaign, while simultaneously reducing their balance sheet, the previous level of liquidity support is being reversed,
  • The reduction in the Fed balance sheet has increased the volatility of the market as the support for equities has been reduced,
  • The screws are being twisted further on both households and speculative-grade corporate debt. It appears the markets have already begun to anticipate more defaults and are repricing risk accordingly.

Fed Balance Sheet

Another big tailwind for the market over the last decade, of course, has been the ongoing “emergency measures” by the Federal Reserve, as well as Global Central Banks  liquidity infusions supported by artificially suppressed interest rates.

As shown in the chart below, the Federal Reserve has previously provided the underlying “Fed Put”which has repeatedly encouraged investors to take on increasing levels of equity risk.

However, with the Fed now on a rate hiking campaign, while simultaneously reducing their balance sheet, the previous level of liquidity support is being reversed.

As shown in the chart below of weekly changes, the reduction in the balance sheet has increased the volatility of the market as the support for equities has been reduced.

While it is currently believed that Central Bankers now have everything “under control,” the reality is they likely don’t. It is far more likely one of following two conclusions is more accurate.

  1. The Fed is absolutely aware the economy is closer to the next recession than not. They also know that hiking interest rates in the current environment will likely accelerate the next downturn. However, the “lesser of two evils” is to face the recession with the Fed funds rate as far from zero as possible, or;
  2. The Fed believes the economic data is indeed trending stronger and are overly confident in their ability to guide the U.S. economy into a “Goldilocks” type scenario where they can control inflationary pressures and growth rates to sustain a lasting economic cycle. 

With the Fed continuing to tighten monetary policy, the screws are being twisted further on both households and speculative-grade corporate debt. It appears the markets have already begun to anticipate more defaults and are repricing risk accordingly.