Despite the hype surrounding yesterday’s meeting of the Federal Open Market Committee (the monetary policy arm of the Federal Reserve), the announcement that followed doesn’t change a thing.
That’s right, nothing. Neither the FOMC statement itself nor Fed Chair Janet Yellen told us anything that the Fed and its proxies hadn’t told us before.
But nevertheless, this is still groundbreaking stuff. It is the most important announcement since the Fed instituted outright QE in March 2009.
And as I have told you in past posts, it will have major implications for the markets and for your money.
There is a lot here that is essential for you understand to protect your money and take advantage of this new policy.
And – fair warning – it’s not bullish.
Here’s what happened, and what you need to know…
They’ve Been Telegraphing this Move for Months
Here’s the important part of the Fed’s statement from yesterday:
In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.
This is not new.
Three months ago, the June 14 FOMC meeting statement was accompanied by an addendum that stated exactly what the Fed would do, that the FOMC statement made official yesterday.
This is a real monetary tightening. It’s not a tightening by higher interest rates, but with the actual reduction of the amount of money in the pool of cash (aka liquidity) available to the markets.
Of course, I’ve been telling you about this for months.
I told you that the process of Fed balance sheet “normalization” would begin in the first month after the announcement – October – and that this would put the short-term LAMMP on a red signal with the long-term LAMPP following suit in a few weeks.
It might take as long as two months, but that signal is coming.
And as I told you on Monday, the Treasury could bring it on even faster as it sells more and more debt now that the debt ceiling has been lifted. When the Treasury sells debt, it is drawing those funds from the same cash pool (the banking system) that the Fed will be shrinking. There will be less money in the system (and more supply of securities) as the Treasury builds up another $500 billion rainy day fund in its account at the Fed. If the Treasury follows through on this, it will have the effect of an even bigger tightening than the Fed’s.
Money fuels demand, so with less fuel available to the dealers, there will be less demand for securities. Falling demand versus increasing supply is a recipe for lower prices. And since stocks and bonds are simply different forms of securities, shrinking the money pool while increasing the supply of bonds will drive both stock and bond prices lower.
So in yesterday’s FOMC statement, the Fed made the policy official. In June, the Fed told us this exact policy was coming. Not even the two massive hurricanes that devastated Texas and Florida could deter the postman from his appointed rounds.
I can assure you that the Primary Dealers and the big hedge funds have gotten the message and are heeding it. It behooves us to heed that message too.
Here’s the Fed’s Plan – And What It Means for Your Money
The Fed told us that it would start by shrinking its balance sheet by $10 billion a month for the first three months. This will siphon $10 billion a month out of “the system,” that giant pool of cash that fuels securities price inflation.
Then in January, the Fed will start draining $20 billion a month from the system. Then $30 billion a month in April 2018, $40 billion a month in July 2018, and finally $50 billion a month in October 2018.
The Fed and its PR handmaidens in the financial media call this “normalization” or even “unwinding.” It all sounds so innocuous, so harmless. What could be bad about “normalizing”?
Well, I prefer to call it what it is: Tightening. Draining. Or pulling the punchbowl. Because that’s what the Fed will be doing. It will be tightening the supply of liquidity. In the first 15 months of the program, the Fed will pull $450 billion from the system.
And supposedly all will be hunky dory?
The Fed doesn’t say where it wants the balance sheet to settle out, but again, those who are plugged into the Fed say that the program will end in 2020. That means that at the final rate of $50 billion per month after one year, the Fed would pull at least another $600 billion from the system in 2019.
Meanwhile, the Treasury is proposing to pull about $700 billion out of the system between now and the end of the first quarter. Either the Fed or the Treasury should have to blink here. The markets would crumble under that kind of combined pressure.
The Fed says that it is embarking on this “normalization” because the US economy is doing just fine, thank you. There’s no longer a need for “accommodation,” its euphemism for insanely loose monetary policy. The Fed says that inflation will return to its target of 2% despite this new program. Why? Well, because they say so, that’s why. The Fed admits it does not know why it has been persistently below target, but they know that it will return to target.
So my outlook is for the market to top out slowly, then head down slowly at first. Complacency will rule the markets in this first phase of the bear. But as the Fed tightens the screws, conditions will devolve into a bear market with lower highs and lower lows probably later in 2018.
The Fed will not realize that it has lost control until it is too late. I can’t forecast how low I think stocks will go yet, but my recommendation is the same. Systematically raise cash in regular increments in the months ahead. I’d want to get to a cash holding of 60-70% by January or March of next year, at the latest, if I weren’t already approaching that goal. The level of cash that’s appropriate for you depends on your personal situation, however.
As a shorter-term trader, I’d look for the early signs that rallies are rolling over as entry points on the short side. I’d do this every few months. Rallies to resistance levels would probably also be good short entries. I would be very cautious and nimble with shorting stocks that are still in uptrends
Meanwhile, I will update you on the status of the LAMPP right here every week and will suggest some ideas for profiting on the short side when I think the timing looks right.