For months, the markets have anticipated the Fed tightening monetary policy in order to take on rising inflation. At the June FOMC meeting, the central bank even hinted that it might start raising interest rates in 2023 instead of 2024, and the central bankers apparently talked about talking about tapering their quantitative easing bond-buying program. But with all of this talk, the loose monetary policy driving inflation continues unabated. Interest rates remain pegged at zero. The Fed balance sheet sets new records week after week. Where exactly is the exit door?
Today, markets eagerly await whatever pronouncements that come out of the Federal Reserve’s July meeting. Analysts and pundits in the financial media will scrutinize every punctuation mark in the FOMC statement and dissect every word that tumbles out of Jerome Powell’s mouth in the coming days. But it’s a near certainty the Fed won’t do anything. It won’t raise interest rates. And it will continue expanding its balance sheet at a torrid pace.
As of July 21, the Fed balance sheet stood at a record $8.24 trillion. In the previous week, the central bank expanded the balance sheet by $39 billion. In July alone, the Fed has added $162 billion to its balance sheet. The Fed can talk about tapering all it wants. The markets can expect the Fed to give up its “transitory inflation” narrative and turn to tightening all they want. But the reality is extraordinary monetary policy continues unabated.
And there’s no sign it will stop any time soon.
The Fed balance sheet has nearly doubled in just a little over one year. It stood at a mere $4.159 trillion on Feb 24, the cusp of the COVID-19 pandemic. The New York Fed projects the balance sheet will top $9 trillion before all is said and done. And I would call that projection very conservative.
In a note, Wells Fargo Institute head of global fixed income strategy Brian Rehling said even when tapering begins, it will take a long time for asset purchases to end.
While Fed tapering whispers may have started, we expect it to be long and drawn out. Once the Fed begins the tapering process, we anticipate it will be about one year before the Fed stops increasing the size of its balance sheet.”
And Rehling said he expects that even after the Fed finishes QE, the balance sheet will remain at its ending level – however high that may end up being – until at least 2025.
The Fed may be thinking about thinking about talking about tapering its asset purchases, but its actions speak much louder than its words.
Quite frankly, I wonder if it will be able to substantively taper QE at all. After all, monetary stimulus is propping up the US economy. An LMAX analyst said the expanding balance sheet is the driving force behind the booming stock market and support for risk assets.
Of course, propped up US corporate earnings didn’t hurt anything either. Eighty-seven percent of companies beat expectations in terms of Q2 performance. But all of this is a function of the unprecedented liquidity pumped into markets over the past decade-plus.”
What happens when you pull out props? Things fall down. The moment the Fed announces substantive monetary tightening, the stock market will tank and corporate earnings will sag. We’ve seen this song and dance before.
The Fed balance grew from $898.6 billion in August 2008 to a peak of just over $4.5 trillion in Jan. 2015. The Fed didn’t get around to significantly shrinking the balance sheet until 2018. The central bankers claimed balance sheet reduction was on autopilot, but that didn’t last long. The balance sheet dipped to $3.76 trillion in late August of 2019. From there it took an upward trajectory. Although they didn’t call it quantitative easing, the Fed had already pivoted back to QE in 2019, long before coronavirus reared its ugly head. In the fall of that year, the stock market tanked. The over-indebted economy couldn’t even handle a modest move toward monetary policy normalization. Once the stock market threw its taper-tantrum, the Fed pivoted back toward loose monetary policy.
Since the onset of the pandemic, the Federal Reserve balance sheet has grown nearly twice as large as it was at its peak in the wake of the Great Recession. Debt has skyrocketed. The US government alone added more than $4 trillion to its debt-load over the last year and a half.
This raises a significant question: how does anybody think the Fed will ever be able to unwind this extraordinary monetary policy? It couldn’t do it after 2008. How can it possibly do it now?
If history provides any indication, the notion of a serious pivot to monetary policy normalization is nothing but a fantasy. The Fed can talk about it as much as it wants. But as the saying goes, talk is cheap. What will the central bank be able to do?
There is no exit door.
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