Control Panel: Double-barreled Fed tightening

By now, all METARs know that the Federal Reserve is planning to reduce inflation by increasing the fed funds rate (an overnight rate) and also reduce their enormous book of long-term Treasury and mortgage bonds, which impacts longer-term interest rates. The Fed continued to buy longer-term bonds long after inflation began to rear its ugly head, suppressing real yields to below zero. While they recently stopped adding, they still haven’t begun to reduce their book, either by sales or by allowing bonds to mature (“running off” the bonds).

The Fed’s book of assets has ballooned to $9 Trillion which is 37% of GDP ($24 Trillion). That is the source of the current bubbles in the stock, bond and real estate markets (not to mention cryptocurrencies and non-financial assets). The Fed currently owns almost 25% of Treasuries and over 30% of mortgage bonds issued by the GSEs. That dramatically suppressed long-term interest and mortgage rates.…

The bond market has been anticipating the Fed’s asset reduction. Treasury yields have risen enough that the real yield of the 10+ year Treasury bonds are finally slightly positive, though nowhere near the historical neutral rate of 2.5% (real yield, add inflation to get the nominal yield).…

**Fed Prepares Double-Barreled Tightening With Bond Runoff**
**Officials’ plans for their $9 trillion asset portfolio reflect many similarities—and differences—from earlier experiment to shrink holdings**
**By Nick Timiraos, The Wall Street Journal, May 1, 2022**


**This Wednesday, officials are to announce plans on how they will shrink their asset holdings. Expect the process to be faster and potentially more disruptive to financial markets than last time....**

**Fed officials have recently indicated that they would allow $95 billion in securities to mature every month — $60 billion in Treasurys and $35 billion in mortgage-backed securities...Runoff is likely to start in June and reach the new caps in just a couple months instead of a year....runoff will start while the Fed raises rates quickly. Officials raised rates a quarter percentage point in March, and this week are set to approve a half-point rate increase, the first in 22 years....**

**Officials are talking about shrinking holdings by around $3 trillion over the next three years... In March officials agreed they might need to eventually sell some mortgage bonds on the open market....Active sales could add to this year’s climb in mortgage rates....** [end quote]

All these plans are assuming that Fed actions are done in a vacuum. In fact, history shows that the Fed is likely to cause a recession. Even a hissy fit from the stock market without a recession has caused the Fed to stop tightening (at the end of 2018). So they may not get too far into their tightening process before backing off. Let’s see if Jerome Powell is as determined to wring inflation out of the system as Paul Volcker was.

The Control Panel is just plain ugly. Stocks are falling, especially the NASDAQ. Volatility is rising, with ± 2+% daily moves becoming common. The percent of SP100 stocks above their 200 day moving average has dropped to under 40 and is below the MA lines. NH-NL and bullish percent have dropped.

Treasury yields are rising across all maturities. The yield curve is basically flat above 2 years but slightly inverted in two places. 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity is slightly positive.

The Fear & Greed Index is moving into Extreme Fear. The trade is risk-off as stocks and junk bonds are falling relative to Treasuries, although they are all falling. Gold and copper are falling, but copper is falling faster than gold. Only the USD is rising. Oil and natgas prices fell a little but have stabilized.

The METAR for next week is stormy. Even though the market has had plenty of warning and built a lot of the Fed’s actions into prices already, I expect a lot of angst when the Fed moves from jawboning to action next week.



and once again Wendy chimes in with our irreplaceable post of the week.

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92% cash. A measly few % in a few hypergrowth SaaS stocks hoping for a turnaround, and another measly few % in a few quality but relatively high yield preferreds.