Warning: The Fed is Preparing to “Pull the Plug” on the Markets
Over the last few days I’ve been warning that the stock market looks ready for a correction.
And as of last night, I’m now convinced: The Fed is preparing to pull the plug on the markets.
As we’ve discussed at length here at Money & Crisis, the primary driver of the stock market since the March 23 bottom has been Fed liquidity, courtesy of the Fed’s massive quantitative easing (QE) programs.
When these programs are running, the Fed’s balance sheet increases. And when they slow down, the Fed’s balance sheet decreases…
Which is why I’m extremely concerned that the Fed balance sheet has begun shrinking for several weeks now. Indeed, it started in early June 2020.
It is not coincidence that the S&P 500 peaked around that date.
Now, much of the prior contractions were due to the Fed reducing its currency swaps – giving US dollars to other banks that needed them. So it makes perfect sense that this component of the Fed’s balance sheet would shrink as the markets recover from the March crisis.
However, this last week the Fed actually drained $24 billion in liquidity from the system. This wasn’t a currency swap…
The End of Federal Reserve Liquidity
This was the Fed actually DRAINING liquidity from the system.
It’d be tempting to see this as a blip or a weird anomaly – except for the fact that yesterday the head of the NY Fed Markets Group, the man in charge of doing the actual buying for the Fed’s QE programs, made a speech indicating that the Fed is planning on reducing its QE programs soon:
Since the SMCCF’s launch, as market functioning has improved, we have slowed the pace of purchases, from about $300 million per day to a bit under $200 million a day. If market conditions continue to improve, Fed purchases could slow further, potentially reaching very low levels or stopping entirely. [Emphasis my own.]
Source: The New York Fed
The Fed is literally warning us that if the markets continue to rally, the Fed is going to “pull the plug” on QE.
And since these QE programs are the No. 1 driver of stocks, this is akin to the Fed warning us that it’s going to “pull the plug” on the markets soon.
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