EDITOR NOTE: If there’s one thing the smarter segment of the stock investing crowd secretly knows but won’t admit, it’s that their bets were based not so much on company earnings and revenue growth but on the money supply growth. It was a liquidity trade, or a “Fed trade.” You simply pick stocks in sectors that may decently perform and then you sit back and watch the Fed do its magic. Well, if you paid attention to the Fed’s statement this week, it should give you a clue as to when this trend may finally end. The Fed is now closing the bulk of its emergency lending facilities due to “low usage.” Jerome Powell doesn’t want America to go the route of Zimbabwe, so it will soon be turning off the liquidity spigot. But here’s the thing: it may be too late. We’ll either see the dollar’s value crash due to the inflationary Pandora’s Box it opened all of last year, or we’ll see a monumental market crash, or we may see both. The markets and economy are out of joint. And the wisest thing you can do now is to hedge both by allocating a good chunk of your portfolio to safe haven assets.
After the rampant inflation of the past year, deflation might be on its way.
As the chart below shows, the Federal Reserve has deliberately inflated the money supply in the United States over the past year at the fastest rate in history. Unless he wants to be known as Chairman Jerome “Robert Mugabe” Powell (and risk Zimbabwe-style hyper-inflation), the Fed’s boss knows that this cannot continue.
This week, The Fed announced that it will close the bulk of the remaining emergency lending facilities that were put in place last year, essentially turning monetary inflation into deflation. Adding to facilities such as the Term Asset-Backed Securities Loan Facility (TALF) that have already shut down, the Commercial Paper Funding Facility (CPPF), the Money Market Mutual Fund Liquidity Facility (MLLF) and the Primary Dealer Credit Facility (PDCF) will all close as of the end of March. No doubt the Fed’s “Head of Acronyms” will be bitterly disappointed.
The Fed is citing “low usage” as its reason for closing down these facilities which fits with the fact that financial markets have stabilized since the turmoil of this time last year. Liquidity appears to be abundant and so, the Fed believes, just as a parent would for a child riding a bicycle, the stabilizers can be taken off the financial economy. Let’s see if the timing is right, or if the bicycle wobbles and then crashes.
Because it’s not a question of if, it’s just a question of when the stock market falls again, and financial conditions tighten. What does the Fed do then? Yep, re-start these inflation programs and probably buy stocks directly. Taking the bicycle analogy further, the Fed has become like a paranoid and overly protective parent, refusing to let the child learn from its mistakes.
Perhaps the most important acronym, though, that the Fed is agonizing over is the SLR, or Supplementary Leverage Ratio. A decision must be made by the end of the month on this one and it has the attention of markets. The SLR requires banks to maintain capital equal to 3 percent of their assets (5 percent for large, systemically important firms). The Fed softened the rules on this last year, allowing banks to exclude holdings of U.S. Treasuries and cash held at the central bank from calculating their assets. This was to enable banks to free-up their balance sheets to lend to businesses and, oh yes, purchase more U.S. Treasuries, thus helping the Fed’s quantitative easing program.
Given that there are already question marks coming through about U.S. Treasury bond auctions, reversing the loosening of the SLR might be taken very badly by markets. A cynic (what, moi?) might say that this is the reason the loose SLR will probably stay.
Originally posted on Deflation.com