The unwinding of the Federal Reserve’s balance sheet has been saved to the end because it is more problematic than either the end of quantitative wheezing or the end of low-interest policy, and it is being carried out be people who have never seen a recession coming in the past and who see no reason to believe we will ever again in our lifetimes see a financial crisis like the last one. By “the Great Unwind,” I mean the reversal of QE (quantitative tightening). While investors are buoyed a little by Yellen’s dovish indication this week that the Fed will only raise interest one more time, the reversal of QE over time will be by far the Fed’s most difficult change toward normalization to navigate.
# JPMorgan Chase & Co. Chairman Jamie Dimon said the unwinding of central bank bond-buying programs is an unprecedented challenge that may be more disruptive than people think.
“We’ve never have had QE like this before, we’ve never had unwinding like this before,” Dimon said at a conference in Paris Tuesday. “Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before. We act like we know exactly how it’s going to happen and we don’t.” All the main buyers of sovereign debt over the last 10 years, financial institutions, central banks, foreign exchange managers, will become net sellers now, he said. (Newsmax)
A risk never experienced in the history of the world. Never is a long time. That risk, anticipated to begin at the end of summer, is far greater than the mere termination of QE that already took place or than the incremental rise in interest rates. This change actually sucks liquidity out of the market, versus slowing the expansion of liquidity.
Considering the Fed has pumped $4.5 trillion of liquidity into the economy to help “recover” from the Great Recession, there is potentially a lot of unwinding to now begin, and it starts in an economy that is limping along the ground, not in the kind of recovery the Fed anticipated rewinding from. Between the European Central Bank, the Bank of the Japan and the Fed, there is $14 trillion to unwind, or, at least, some large portion of that.
The Great Unwind happens in a period where global debt has reached $217 trillion, which presents a major problem for the Fed in selling off so many bonds. They will almost certainly have to offer them at better yields more interest in order to attract buyers. That sifts throughout debt markets to raise the interest on carrying or refinancing all of this debt. Nations will have to compete with central bank yields in order to issue new debt or refi old. The European Central Bank and Bank of Japan are also looking like they may start unwinding soon, so compound all of that in your mind.
“As I believe the main factor in driving market multiples to historically high levels was QE, ZIRP and NIRP, then yes, the reversal will have major implications for markets and volatility.” Peter Boockvar, chief market analyst at The Lindsey Group, told MarketWatch.
The Fed’s Great Unwind is scheduled to start (if the Fed’s hints bear out) during the stock market’s unwind from Trumphoria, too, and during the retail apocalypse and auto market crash:
Crispin Odey, who made money for a second straight month by sticking to bearish equity bets, said the chance of a market crash is rising as growth slows and the Federal Reserve normalizes interest rates.
The credit cycle boosted by loose monetary policy has peaked and there’s a widespread slowdown in the auto, commodity, industrial and retail sectors, Odey wrote in a letter to investors. Unlike previous dips since the financial crisis, central banks aren’t responding by printing more money.
“This time they are doing the reverse,” which is likely to exacerbate the negative trend, the London-based hedge fund manager wrote. “All this sits very uncomfortably with the fun being felt in the stock markets. When I look at the move up since Trump’s election as president, I detect the walk of a drunken man. The chances of car crashes everywhere are rising,” according to Odey. “Enjoy the hot summer,” (Newsmax)
The timing for the Fed’s Great Unwind does not look fortuitous. Key to understanding why the Federal Reserve always has such bad timing so that it routinely crashes its own recoveries can be found in recognizing that the Fed’s dual mandate, setting monetary guidance based on maximizing jobs and maintaining inflation at a set level, means the Fed is always aiming to create goals that may take a year to develop from the time they make any change.
Inflation is largely dependent on the wage/labor market, and a change in hiring decisions is dependent first on a change in economic conditions; so the movement of these lagging indicators that the Fed monitors the most can easily be a year or more away. Thus, the Fed will continue to move every quarter more and more toward their new bias of stimulus reduction until they see the results in their job and inflation metrics. But they are doing that when the economy is already receding. By the time they see the results in their two sacred metrics, they’ve moved further than they need to and downhill momentum has already built up.
So, they will do it again....