The Fed Needs to Walk Back Its QT Program NOW

We should have known better… for the gods are eager to punish hubris.

On May 17, we forecast the S&P would take a good tumble two weeks later, May 31.

We were magnificently, triumphantly correct — the S&P dropped 19 points that day.

Inflated by success — or deceived by chance — we ventured upon another prediction.

Last Friday we said the S&P would drop this Monday, July 2.

Our logic was airtight…

On all but one occasion when the Federal Reserve cut into its balance sheet this year, the S&P closed lower that day.

And this past weekend the Fed dropped over $30 billion from the its mammoth $4.3 balance sheet — its largest balance sheet reduction to date.

Sure as sugar, the S&P traded lower all day Monday.

And we prepared to thump our victorious chest yet again.

But by late afternoon the gods moved against us… the market rallied… and the S&P ended the day higher.

Thus we depart the prediction business with a 50% win rate — or loss rate.

We nonetheless look ahead… wiser for the experience.

$30 billion last month, the pace of quantitative tightening (QT) quickens to $50 this month.

Meantime, the European Central Bank is reducing its quantitative easing (QE) program to $30 billion per month.

The math therefore reveals a pending $20 billion liquidity drain (30-50 = -20).

Which brings us to this gobsmacking conclusion, coming by way of Phoenix Capital:

This is the FIRST time since 2008 that global market monetary policy will be NEGATIVE: More money will be leaving the system via QT than will be entering it via QE.

Is that not a capital fact — that more money will be leaving the system than entering for the first time since 2008?

Yet our searches reveal nothing of it in the mainstream financial press.

Of its significance Phoenix Capital is clear:

“The S&P 500 is on VERY thin ice,” they conclude, affirming their demonstrated fondness for CAPITALS.

What then is their advice for the Federal Reserve?

The Fed needs to walk back its QT program NOW or else it is risking a bear market for U.S. stocks.

The folks at Phoenix Capital sound lots like Jim Rickards.

Jim’s been high on his rooftop, hollering the same warnings.

Its rate hikes are one thing, says Jim.

Mix in QT and the Fed toys with fire:

The Fed is giving a weak economy a double dose of tightening in the form of rate hikes and the unprecedented destruction of base money as they unwind QE… It has never been attempted in the 105-year history of the Fed.

Quite simply, the Fed has no idea what it is doing. The Fed is overtightening right now and does not even realize it.

But Mr. Jerome Powell gives every indication he’ll keep the business going at the projected rate.

You can expect two additional rate hikes this year… and a full calendar of QT.

Unless, of course, stocks fall through the VERY thin ice upon which they presently skate.

How slender is that ice?

Bank of America informs us the vast majority of stock purchases this year have been buybacks — corporations buying their own stock.

Q1 2018 established a fresh record for buybacks — $242.1 billion.

But Q2 buybacks nearly doubled that record amount… to $433.6 billion.

What would happen to markets without buybacks?

We may soon have an answer — at least in part.

Many corporations have entered a buyback “blackout” period.

A blackout period?

Many corporations will announce quarterly earnings later this month.

And the law forbids buybacks during a five-week span before they announce these earnings.

Thus the market is going without many of the buybacks that have kept it afloat this year.

Charles Schwab analyst Jeffrey Kleintop estimated in late June:

With the peak in the second-quarter earnings reporting season about five weeks away, we may be losing the buying support from corporations.

Adds Zero Hedge:

Without buybacks, there will be little buying pressure on stocks. Which is a problem because with just days left until [the] buyback blackout period, the buyer of last resort for U.S. stocks is about to go on a month-long vacation just as the trade war between the U.S. and China begins.

Ah, yes, the trade war…

Tariffs on Chinese imports take effect tomorrow.

Chinese authorities have pledged immediate countertariffs.

Meantime, the next QT date is July 31, when several billion more will drop from the Fed’s balance sheet.

Buyback blackouts… trade wars… more QT from the Fed… less QE from the ECB.

Upon deeper reflection…

We may soon be back in the forecasting business…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning