The Fed is again expanding its balance sheet in response to the recent interest rate spike in repo markets. The effect is the same as QE: the Fed is creating new money (reserve balances) and pumping this into financial markets.
Why is this happening?
The US government is issuing record amounts of new Treasuries to cover Donald Trump’s record deficit.
According to Luke Gromen: “US govt is on pace to issue $11.3T in USTs on a gross basis in F19.”
Gregor Samsa at Macro-Monitor sums up the problem with the following diagram.
If supply-demand curves do your head in, the above graph simply says that when you suppress interest rates, there will be a surplus of Treasuries. The yield is less attractive and demand from investors will fall.
Not only do we not have enough domestic buyers, foreign (Chinese?) purchases of US Treasuries are drying up. Primary dealers are required to take up the shortfall on any new issues. The recent price spike tells us they don’t want them.
So it’s all hands to the pump at the Fed. We are likely to see further balance sheet expansion in the months ahead, driving down Treasury yields and the Dollar.
And lifting equities.
The flush of new money is likely to suppress volatility.
And drive equities even further out along the risk curve. Breakout above 3025 would signal another advance.
We remain cautious. Stocks are highly-priced compared to earnings.
Corporate profits are falling in real terms.
And rising personal savings warn that consumption is likely to fall.
It all depends on how much money the Fed will print.
