Monday, December 19, 2016

U.S. Fed Official Calls For Reversing QE: One Chart Says It All

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*On Friday, St Louis Fed President and 2016 Fed voting member James Bullard said he'd like the Federal Reserve balances to begin to run off.

*We've viewed this as the single biggest risk to US markets.

*A picture says 1000 words. You need to see for yourself what shrinking these Fed balances implies for markets.

One of the more dovish Fed voting members, St Louis Fed President James Bullard is getting more hawkish. More important than his call for an additional rate hike in 2017 was his stated goal to let the Federal Reserve Balances begin to runoff and shrink. These balances were built in the days of quantitative easing. Reinvesting maturing principles is causing the Fed to regularly buy bonds at current prices. Allowing these bonds to run off removes this major buyer and is an added risk to markets.

Visual Perspective Of What Shrinking Fed Assets Means

Data Sources: SOMA and Yahoo, Chart By Elazar Advisors, LLC
Above you have the S&P ETF SPY in green versus the Fed balances in yellow indexed to the SPY for comparison purposes.
You can see when Fed balances dropped in 2008 it helped crash markets (must reads for the full picture of this critical story explained here and here). After the 2008 crash the Fed made sure the markets would hold up with a huge amount of bond buying (the yellow line).
This yellow line is what Fed President James Bullard is calling to shrink in 2017.
Which way will stocks go when that yellow line comes back down?

If that yellow line starts to come down we think it's a major market risk. That little drop in the yellow line in 2008 crushed markets. The catapult in Fed balances helped support and raise markets. The dropping of this value can help crash markets once again.

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