For 9 years I’ve been talking about the unintended consequences of the Fed’s policies. The growth rate of the economy during this bull market has been the worst on record, yet it is now the third highest gaining bull market in history. What happened? The Fed gave everyone a false confidence that they would always be there to prevent another crisis. Along the way they bought $1.7 Trillion in Mortgage Backed Securities (MBS) & $2.4 Trillion of Treasury Bonds from the Wall Street banks. At one point the Fed was reported to be 95-100% of the MBS “market” and over 80% of the Treasury “market” when it came to auctions.
At some point logic told us they’d have to unwind this colossal balance sheet. The Fed assured us it would be “calm & orderly”, which is easier said than done. One other thing I’ve pointed out for the past 9 years — nobody knows how this will end because we’ve never seen a central bank take such unprecedented measures to support the financial (stock) markets. We are witnessing one giant classroom experiment.
On Wednesday the Fed shook the confidence of investors when they released the minutes of their March meeting. In the meeting there was a long discussion of how to unwind the balance sheet and the consensus was it needed to be done this year. The Fed minutes were released at 2 pm. This chart shows the last 5 days’ performance of the S&P 500.I put the cursor on the chart at 1:55pm. CNBC reported this reversal was the worst in 14 months for the S&P 500. Small cap stocks were hit even harder.
Based on Janet Yellen’s history, if this keeps up for a few more days she will send her minions out to back away from the “unwind”, but it is a warning to all of us that sooner or later the Fed will be forced to unwind their balance sheet and when they are it will not be pretty.