- Stock market analysts and economists say stock prices are soaring because of the Fed. And they’ll crash when the QE party is over.
- The Federal Reserve’s balance sheet is expanding nearly twice as fast as it did during QE3 in 2012. Turning off the tap could be dangerous.
- Markets don’t expect any changes after the Fed policy meeting this week. But analysts forecast a major slowdown in operations this year.
U.S. stock market analysts don’t expect any shift in monetary policy after the Federal Open Market Committee meeting this week. On Friday, a note from JP Morgan said the FOMC meeting should be “one of the least eventful meetings in recent years.”
But don’t expect the high liquidity, low-interest rate party to last forever. It’s just like Cinderella’s ball, as Warren Buffett would say. Traders keep sticking around for another dance. But the clock will eventually strike midnight. And when the monetary magic wears off, the rally will turn into pumpkins and mice.
As Buffett once said:
Nothing sedates rationality like large doses of effortless money. Normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party.
Not everyone agrees that the Fed is behind the stock market boom in recent months. Wall Street bulls point to the U.S.-China trade war winding down, alongside good news about the economy. But it’s hard to ignore the scale of Fed operations since September.
Fed Operations Sent the Stock Market Soaring
In October, Federal Reserve Chair Jerome Powell said:
This is not QE.
Our Treasury bill purchases should not be confused with the large-scale asset purchase programs that we deployed after the financial crisis.
The Federal Reserve’s balance sheet has grown by $386 billion since September. That’s $77 billion a month. QE3 was $40 billion a month. That’s going to impact the stock market.
You can debate it all you want, but as long as the flows are increasing the size of the balance sheet, stocks are going to rise in price.
The S&P 500 Index grew at the same pace as the Fed’s balance sheet as it began overnight repo operations in earnest.
Morgan Stanley Asset Management’s CIO, Lisa Shalett, doesn’t think the stock market correlation is a coincidence:
Financial conditions are extraordinarily loose and accommodative… definitely contributing to this move in the market.
But it’s not going to last forever.
The Fed Is Going to Slow Down in 2020
"The debt is growing faster than the economy. It's as simple as that. That is by definition unsustainable. And it is growing faster in the United States by a significant margin."
– Jerome Powell, Chair of the Federal Reserve – Nov. 2019
A storm is coming. pic.twitter.com/uBiJwnebjM
— C.S. Connaughton (@TheSuperbubble) November 20, 2019
Markets don’t expect anything to change after the Fed’s first policy meeting of 2020. Ahead of the January meeting, the market consensus was an 87 percent chance of no change.
But the Fed’s carrying a heavy load on its books, and Morgan Stanley’s chief cross-asset strategist Andrew Sheets forecasts that QE lite ends in April:
Morgan Stanley experts think the Fed wants to end its $60 billion-a-month purchases of Treasury bills at the end of April and let its balance sheet plateau. In its place, they expect a smaller $15 billion-a-month of purchases across the Treasury curve, Sheets said.
Economic chief Diane Swonk predicts doom for stock prices if that happens:
Many financial market participants believe that the liquidity provided by the Fed has helped to boost stock prices above and beyond what rate cuts alone could do; any moves to stop that growth could show up as a loss in momentum for stock prices.
If the stock market is not only directly buoyed by Fed liquidity, but pricing in the expectation of more going forward, the adjustment could be a painful one.
After gaining so exuberantly, there could be a drastic correction.
Then you could check off all four boxes that preceded the worst intraday stock market crash in history.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.