Fed Balance Sheet Projections

Posted By Darren Winters on Sep 29, 2020


Fed Balance Sheet Projections

Aligning trading positions with Fed balance sheet projections could be the holy grail to achieving alpha returns.

A thought-provoking piece in Zerohedge notes that Quants have discovered a guaranteed source of alpha, which is to trade based on the growth of the Fed balance sheet.

In other words, the disconnect between financial asset prices and the fundamentals are a continuing theme. 

Fed balance sheet projections continues to be a major factor in the equation of the dicey business of forecasting asset prices

Financial markets remain the Fed’s trillion dollars perpetual motion machine.

When the Fed wants financial assets, stock, and bonds to rise it creates currency and buys them, and its balance sheet of assets expands, this is known as quantitative easing QE. 

So rising stock and bond prices are a function of QE and QE to infinity mean stock prices keep rising irrespective of where the real economy is heading.

Moreover, if the Fed wanted to stop the bull market in its tracks it does the inverse of QE and reduces its monthly asset purchases, which is known as quantitative tightening QT.

In other words, aligning trading positions with Fed balance sheet projections might be the only way to play these Fed “managed markets”

Fed balance sheet projections

The Fed and its cohorts, the ECB, BoJ, and BoE have become the head traders, and the best play could be to front loading or copycatting the head traders’ trades. Perhaps the Quants, computer programs, have been program to do just that, aligning trading positions with Fed balance sheet projections.

But, the trading strategy, aligning trading positions with Fed balance sheet projections is no great revelation, as I was writing this in a piece, entitled Fed’s Balance Sheet, dated January 16, 2020. 

“All eyes are on the Fed’s balance sheet,” I wrote back in January. 

“So has the Fed run out of firepower, as many commentators believe?

The answer is no if you think that the Fed’s balance sheet can keep expanding,” I wrote.

“The world’s reserve currency the USD is backed by nothing other than trust and military might the Fed’s creation of dollars is theoretically infinite and that too implies that the Fed’s balance sheet expansion can go to 4 trillion USD and beyond,” I added. 

Aligning trading positions with Fed balance sheet projections and QE purchases in the pandemic economy would have yielded sizeable returns

The Dow closed out its best second quarter since 1987 driven by the Fed balance sheet expansion. The Fed, the world central bank by default ramped up its QE program with its balance sheet swelling to nearly $7 trillion in June since the outbreak.

Who would have thought that the Fed’s balance sheet would have gone 4 trillion USD in January to 7 trillion USD in June of the same year? 

But it was not just the Fed that has since ramped up its QE program in the pandemic era of rolling lockdowns which is slowly bleeding the economy dry and could even cause a humanitarian crisis in developed advanced economies.

So too has the European Central Bank ECB swung open its liquidity tap with the €750 billion Pandemic Emergency Purchase Program (PEPP), which was focused nearly all on government bonds where it purchased €186.6 billion of public-sector securities using the program. 

The ECB disproportionately bought Italian and Spanish sovereign bonds, thereby reducing the spread between peripheral sovereign bond yields.

Moreover, the Bank of England (BOE) has adopted policies in tandem with other major central banks in its pandemic response to the great lockdowns.

Since the beginning of the pandemic, the BOE has cut rates twice from 0.75% to 0.1%.

The BOE also announced £200 billion ($247.55 billion) of additional QE, bringing its bond-buying program to a total of £645 billion, as of June 2020.

The 2020 pandemic great global lockdowns sent the global economy into free fall in the second half of 2020. Meanwhile, the main stock indices experienced the greatest rally in decades due to the major central banks ramping up QE

The latest pandemic rally in stocks is indisputable proof that aligning trading positions with Fed balance sheet projections is all that counts in a central bank-controlled system

So, it is the central banks and not the free market that will decide which companies survive, fit the agenda, and which ones will go to the wall. 

What’s more, if there is anyone left in the room that still believes that aligning trading positions with Fed balance sheet projections has no impact on asset prices whatsoever then what do you think happened when the Fed attempted to taper QE?

When the Fed’s balance sheet contracted back in late 2018, in other words when the Fed became a net seller of assets, in other words adopted a policy of quantitative tightening QT, stocks crashed. So a head-spinning, jaw-dropping stock market crash in December 2018, the worst December for stocks since the Great Depression was due to the Fed’s balance sheet contraction, or QT.

So that is it in a nutshell, while the government responses to the lockdown are slowly extinguishing the economy, driving millions into homelessness and poverty and mainstream coins it the “new normal” the erosion of civil liberties, the right to assembly, family life continues to melt away. Continental Europe experienced this tyranny in the 40s, it is neither new nor is it normal.

But while democracies wither and economies meltdown in this imposed new normal of mandatory wearing the mass fear symbol, the mask, the lockdowns, social distancing to fight a pandemic, which even medical professionals are rejecting, all that counts is aligning trading positions with the Fed balance sheet projections. In the era of deception, fake money is keeping a fake bull market alive on a fake narrative. Stocks rally on forced optimism.

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