The Fed’s Monetary Tightening Is The Stock Market Bull’s Death Knell

Monday, October 1, 2018
By Paul Martin
October 1, 2018

The Fed steps up its balance sheet tightening to full-steam this month, and that is a dire threat to the stock market. Here’s why…

by Adam Hamilton of Zeal LLC

The Federal Reserve’s unprecedented quantitative-tightening campaign is finally ramping to its full-steam speed in Q4. That will destroy $50b per month of quantitative-easing money created out of thin air! QT will need to maintain this terminal pace for over two years to meaningfully unwind the Fed’s grotesquely-bloated balance sheet. This record tightening poses a dire threat to today’s QE-inflated overvalued stock markets.

This week traders are focused on the Fed’s 8th rate hike of this cycle, which was universally expected. Ever since the FOMC’s previous meeting in early August, federal-funds futures have implied odds of another hike way up at 91% to 100% at this latest meeting. But the Fed’s ongoing hiking pales in comparison with what it’s doing with its balance sheet. One year after its birth, quantitative tightening is hitting full speed.

Rightfully concerned about QT’s impact on the lofty stock markets, the Fed prudently took an entire year to ramp it up to terminal velocity. QT started almost imperceptibly at $10b per month in Q4’17, before being ratcheted up another $10b monthly in each subsequent calendar quarter. The final increase is going into effect in this imminent Q4’18, taking QT to a staggering $50b-per-month pace. That’s record tightening!

QT is incredibly bearish for today’s record-high, bubble-valued stock markets late in a record bull that was largely driven by the Fed’s earlier extreme quantitative easing. QE conjured literally trillions of dollars out of thin air to keep interest rates artificially low, greatly boosting stocks in multiple ways. QE left bond yields uncompetitive with stock dividends, “justified” extreme stock overvaluations, and fueled epic stock buybacks.

QT threatens to reverse all that, restoring interest rates to more-normal levels. That will ultimately wreak havoc in stock markets heavily dependent on anomalous suppressed interest rates. Rising bond yields will attract back income-seeking investors, sucking capital out of far-riskier dividend-paying stocks. And higher rates will make it much more expensive for corporations to borrow money to buy back their own stocks.

In order to grasp QT’s dire threat to these stock markets, we have to understand how they got way up here. This first chart superimposes the flagship US S&P 500 broad-market stock index (SPX) over the Fed’s balance sheet since 2009, the entire span of this monster stock bull. The orange line is the Fed’s total balance sheet, inside which is stacked total US Treasury QE in red on top of mortgage-bond QE in yellow.

The Rest…HERE

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