Start of a new era

[MichaelB]

Today, June 1, the decade long policy of quantitive easing comes to an end and quantitative tightening begins.

About US$ 1T is expected to be withdrawn from the financial system by year end and at least another 1T next year. No one really knows how this will impact us, but there are lots of theories. Here’s one, from former Fed trader Joseph Wang https://fedguy.com/turbo-tightening/#more-4493

The money supply is set to contract just as investors are clamoring for cash to hide from declines in both equities and bonds. A combination of increasing MMF allocation to the RRP and QT may drain ~$1t of bank deposits by the end of the year. The Treasury’s decision to further cut bill issuance will keep money market rates very low and likely push the RRP to over $2.5t by the end of the year. Furthermore, recent history suggests QT will largely be funded by deposits held in banking system rather than the RRP. The combination of these two mechanisms suggests a net contraction in bank deposits despite elevated bank credit creation. Investors looking to hide in cash will have to compete for a shrinking pool of cash by further lowering the asking prices of their assets. In this post we describe the mechanics behind the impending rapid withdraw of cash and suggest the market rout will continue.

One of the things I find most unusual about this is there is very little opposition.

 

[aja8888]

My understanding of what will start with QT will be allowing mortgage back securities (MBS) held by the FED to just "roll off" as the loans are paid off or an asset sale closes the loan out. Treasuries will be allowed to mature without renewal.

Of course during this QT process, the FED will not be buying tons of MBS's monthly like it has been.

Opposition? Most folks have no idea what the FED does. One thing they have not done is pay any attention to the Taylor Rule!

 

[marko]

Nothing to add except noting a real [-]fear[/-] concern that everything I've learned about investing over the past decade no longer applies.

Hoping for insight on posts to follow.

 

[MichaelB]

My understanding of what will start with QT will be allowing mortgage back securities (MBS) held by the FED to just "roll off" as the loans are paid off or an asset sale closes the loan out. Treasuries will be allowed to mature without renewal.

Of course during this QT process, the FED will not be buying tons of MBS's monthly like it has been.

Opposition? Most folks have no idea what the FED does. One thing they have not done is pay any attention to the Taylor Rule!

Mostly Treasuries. From the Fed website https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504b.htm

For Treasury securities, the cap will initially be set at $30 billion per month and after three months will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills.
For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month and after three months will increase to $35 billion per month.

Nothing to add except noting a real [-]fear[/-] concern that everything I've learned about investing over the past decade no longer applies.

Hoping for insight on posts to follow.

I know. Unfortunately, there’s not much insight out there to be had. Most opinions are speculation, because there’s no history of Fed actions of this magnitude to study.

 

[aja8888]

It will be interesting to see what happens when the QT is in full bloom and liquidity is pulled out of the system. Couple this with increasing interest rates (FED funds Rate) and mortgage rates will continue to rise putting damper on house price increases.

A good friend of mine here in Houston, who is a very successful mortgage broker, just told me over the weekend that his office let several brokers go (layoff). He said he has no new mortgage applications in process and refi's died a few months ago.

Jamie Dimon said in an article on CNBC today to "brace yourself" for an economic hurricane:

https://www.cnbc.com/2022/06/01/jam...ricane-caused-by-the-fed-and-ukraine-war.html

“We’ve never had QT like this, so you’re looking at something you could be writing history books on for 50 years,” Dimon said. Several aspects of quantitative easing programs “backfired,” including negative rates, which he called a “huge mistake.”

 

[frayne]

OK, I'll admit much of this is above my comprehension level but what does this mean for the ordinary investor, the fed put too much air into the balloon and now it's going to let too much out, too quickly and wreck the economy ? Dimon's comment about all these storm clouds may dissipate, tell me his crystal ball isn't all that clear and his current prognostications are stating the obvious at this moment in time i.e., war, famine, pestilence, etc., etc. Full disclosure, JPM stock holder here and a Jamie fan as well.

 

[copyright1997reloaded]

It will be interesting to see what happens when the QT is in full bloom and liquidity is pulled out of the system. Couple this with increasing interest rates (FED funds Rate) and mortgage rates will continue to rise putting damper on house price increases.

A good friend of mine here in Houston, who is a very successful mortgage broker, just told me over the weekend that his office let several brokers go (layoff). He said he has no new mortgage applications in process and refi's died a few months ago.

Jamie Dimon said in an article on CNBC today to "brace yourself" for an economic hurricane:

https://www.cnbc.com/2022/06/01/jam...ricane-caused-by-the-fed-and-ukraine-war.html

Next up will be a bunch of unemployment for those who build new housing (and inspectors, and ...) Higher mortgage rates will cause this in two ways: 1) The combination of higher prices and higher mortgage rates will make many houses too expensive, and 2) those who have a low, locked in 30 year rate (e.g. < 3%) who might have moved up will not do so - because they won't be able to keep that low rate nor can they even pass it on to the next buyer (i.e. not assumable). This will cause many of them to stay put in their current house. The net results of both of these factors will likely be a severe contraction in new building activity.

How the above impacts places like HD and Lowes....not sure of that as I don't really know how much of their sales is new build activities. Those who are stuck in existing homes w/low rates (and still have their jobs) might due more rehab kinds of things (especially if the supply becomes more available). Having said that, not sure I would want to be long HD/Lowes at this point.

 

[razztazz]

So, why exactly have we needed a program/policy like "quantitative easing" for 10+ years?

 

[copyright1997reloaded]

So, why exactly have we needed a program/policy like "quantitative easing" for 10+ years?

Because once you are on crack, it is hard to stop?

 

[Montecfo]

Next up will be a bunch of unemployment for those who build new housing (and inspectors, and ...) Higher mortgage rates will cause this in two ways: 1) The combination of higher prices and higher mortgage rates will make many houses too expensive, and 2) those who have a low, locked in 30 year rate (e.g. < 3%) who might have moved up will not do so - because they won't be able to keep that low rate nor can they even pass it on to the next buyer (i.e. not assumable). This will cause many of them to stay put in their current house. The net results of both of these factors will likely be a severe contraction in new building activity.

How the above impacts places like HD and Lowes....not sure of that as I don't really know how much of their sales is new build activities. Those who are stuck in existing homes w/low rates (and still have their jobs) might due more rehab kinds of things (especially if the supply becomes more available). Having said that, not sure I would want to be long HD/Lowes at this point.

I still like them both but esp Lowes. It is more focused on the consumer.

I have found these to be pretty good holdings over time. When rates rise and people stay put, they fix up their houses.

 

[Walt34]

How the above impacts places like HD and Lowes....not sure of that as I don't really know how much of their sales is new build activities. Those who are stuck in existing homes w/low rates (and still have their jobs) might due more rehab kinds of things (especially if the supply becomes more available).

I still like them both but esp Lowes. It is more focused on the consumer.

If memory serves, during the 2008 crash Home Depot and Lowes did very well because so many people had little choice but to stay where they were and make the best of their current house.

But I'm an index guy so this is academic to me.

 

[Koolau]

OK, I'll admit much of this is above my comprehension level but what does this mean for the ordinary investor, the fed put too much air into the balloon and now it's going to let too much out, too quickly and wreck the economy ? Dimon's comment about all these storm clouds may dissipate, tell me his crystal ball isn't all that clear and his current prognostications are stating the obvious at this moment in time i.e., war, famine, pestilence, etc., etc. Full disclosure, JPM stock holder here and a Jamie fan as well.

Yeah, I can buy that there may be a hurricane coming but I have no idea how to prepare for it. Anyone here who believes in the hurricane theory, feel free to share what you are doing to prepare - would be much appreciated.

 

[SecondCor521]

Opinions I hear are all over the map.

If I heard him correctly, Powell seems to think that all the QT they're scheduled to do is about equal to a 1/4 point rate increase on the Fed funds rate, so it really isn't much.

Sure, it's unprecedented, but I think we understand generally what QT is going to do. The only thing we don't know for sure is how strong the effects will be. I think they'll be able to tell after a few months and then can adjust.

I'm not surprised that people aren't following Dimon like he's an oracle. I know he's a smart guy and runs a pretty large financial institution. But what is his track record on predictions? As far as I can tell, he's just one voice among many smart people, some of which are talking about market recoveries and soft landings later this year. Who knows who is right? Not me.

 

[Koolau]

Just tonight I saw someone from one of the big brokerage houses suggesting that, not only was Dimon right that a hurricane is coming - but it's gonna be a Cat 5. Wish I could recall the details (which guy/which house.) YMMV

 

[jm67]

Next up will be a bunch of unemployment for those who build new housing (and inspectors, and ...) Higher mortgage rates will cause this in two ways: 1) The combination of higher prices and higher mortgage rates will make many houses too expensive, and 2) those who have a low, locked in 30 year rate (e.g. < 3%) who might have moved up will not do so - because they won't be able to keep that low rate nor can they even pass it on to the next buyer (i.e. not assumable). This will cause many of them to stay put in their current house. The net results of both of these factors will likely be a severe contraction in new building activity.

How the above impacts places like HD and Lowes....not sure of that as I don't really know how much of their sales is new build activities. Those who are stuck in existing homes w/low rates (and still have their jobs) might due more rehab kinds of things (especially if the supply becomes more available). Having said that, not sure I would want to be long HD/Lowes at this point.

Why do you think housing prices will continue to increase as mortgage rates rise? The opposite should occur. After all the whole point of QT is to tame inflation. I have no idea what the next years will bring, but the “doom and gloom” scenarios seem overstated. I’m planning for a moderate 12 month recession of the sort we’ve seen many times before.

 

[copyright1997reloaded]

Why do you think housing prices will continue to increase as mortgage rates rise? The opposite should occur. After all the whole point of QT is to tame inflation. I have no idea what the next years will bring, but the “doom and gloom” scenarios seem overstated. I’m planning for a moderate 12 month recession of the sort we’ve seen many times before.

Perhaps I wasn't clear enough. Prices have ALREADY risen A LOT in housing. This in conjunction with higher mortgage rates makes housing unaffordable to many.

QT and what the Federal Reserve have done (so far) is a joke. When COVID hit, the Fed dropped rates from 1.5% to zero in two steps, on March 3, 2020 and March 15, 2020. They didn't talk about it for six months before hand, and they did not do a little bit and then wait for the next meeting (the second drop was between regularly scheduled meetings). It's all a game - first there is no inflation, then it is "transitory", then even when the geniuses knew it wasn't transitory - they still waited. Then they did a small increase, but still kept the QE in place. The result is that they are severely behind the curve...with inflation over 8% a .75%-1.00% federal funds rate is (repeated here) a joke.

Even now, QT has barely started - as I understand it the first items to mature won't take place until a couple weeks into June.

What has been interesting to me is the markets reaction to minimal hiking. The Q1 GDP had a negative print. If we get a negative print Q2 then we will "officially" be in a recession. More worrisome was the dramatic decline in GDP growth (to drop) from Q4 2021 (6.9%) to Q1 2022 (-1.5%).

Me? I don't think we've seen anything yet. The inflation we've seen so far does not really reflect food shortages due to the war in Ukraine.

It is now summer in the North East where 85% of the fuel oil for heating homes is used. How will people's spending (on other goods/services) be impacted this coming winter? In Nov. 2020, fuel oil averaged $2.12/gallon, now $5.13/gallon (and rising). Let's use my house as an example: Without burning wood, I would use around 1200 gallons of fuel oil per year (that includes domestic hot water) - and that is with keeping the house at 60 or so during the winter. So that would be $6156/year at current prices, $9600 if fuel oil/diesel reaches $8/gallon. Can I afford it? Yes, but that kind of coin is going to impact the spending of a LOT of people.

On the food front, Poland is racing to try to help Ukraine export its wheat crop, but estimate that they will be able to (at best) move 1/3 of the wheat in the upcoming weeks. My nephew keeps getting emails from the USDA telling him he can request early termination of CRP contracts w/o penalty (i.e. instead plant).

Each of us has to assess what is to come, and place our bets accordingly. Perhaps you will be correct, we will have a "moderate" recession. Certainly that is what most have been predicting. After all, both the government experts and the federal reserve think we have the best economy, and Powell (March 16) didn't see a recession in 2022. I am not among them.

Does this mean I've sold all my stocks and proceeded to my bunker? No. As I've stated, I think the fed will "pivot" sooner than expected...they will see some moderation in inflation and declared victory, but it really will be because of deteriorating economic conditions. So, I can't just sell out because stocks remain a better than nothing inflation hedge.

 

[Koolau]

Yeah, no one has a crystal ball that lets know how bad it's gonna get. My gut tells me this could be a hurricane as mentioned. So many things have gone into the run up (years of QE, impact of Covid - especially helicopter money, Ukraine, denial that inflation is real.) Unwinding all this could really be messy. But, then again, just because I can see the problems doesn't mean I have a clue about how (or if) they will be solved. Eventually, "this time it WILL be different" will be true. Let's hope it's not this time. YMMV

 

[Lsbcal]

I don't have a model for the economy and it sounds like most of this QT discussion is anxious guessing. Today the unemployment rate reported as steady at 3.6%. That is not a situation that is associated with recessions. Really bad (sustained declining) markets are associated with recessions.

If the unemployment rate moved up to the late 2021 numbers that would be a bad sign when coupled with a declining SP500.

 

[jim584672]

One thing no one would think, soft landing! Too much doom and gloom around.

I have no idea what is going to happen.

 

[corn18]

So, why exactly have we needed a program/policy like "quantitative easing" for 10+ years?

Because if they hadn't done it in 2009, we would have had another great depression, not a great recession. Fed just went too far. Now when they unwind it, we will have a recession. Maybe several of them.

 

[razztazz]

Because if they hadn't done it in 2009, we would have had another great depression, not a great recession. Fed just went too far. Now when they unwind it, we will have a recession. Maybe several of them.

Thank you. I just wanted to hear somebody else say it. The economy never recovered. It just stayed on life support. It's not a case of the fed going too far. 10+ years is a long, if I may , g/d time. They didn't "overdo it". They had to keep doing it. Everybody involved knew that it was the only thing keeping air in the ball. The Captains of industry knew they couldn't live and get rich without it so they couldn't afford to switch back to capitalism.

 

[MichaelB]

I have no idea what is going to happen.

Neither do I, and my belief is no one really knows, but fear of the unknown is a powerful force.

I think Fed QT is a good move and will have a positive impact. The real economy, the part that produces real stuff for people, is doing just fine. It will need to adjust to higher interest rates, but as long as demand for the goods and services continues, that’s not a problem, and demand looks healthy, as does the employment outlook.

The impact of this will be greatest on the financial economy. Hedge funds, private equity, venture capital, and the profitless tech businesses, will all suffer because they don’t produce anything of intrinsic value but they badly need more and more easy money to finance their risk investments. As the Fed withdraws cash reserves from the banking system, the funds available for these risk investments that generate no cash flow of their own will get much more costly and difficult to borrow. IMO that is good.

Jamie Dimon is right to be concerned. This affects his business, which every day is less and less related to the economy of real goods and services.

 

[Koolau]

I don't have a model for the economy and it sounds like most of this QT discussion is anxious guessing. Today the unemployment rate reported as steady at 3.6%. That is not a situation that is associated with recessions. Really bad (sustained declining) markets are associated with recessions.

If the unemployment rate moved up to the late 2021 numbers that would be a bad sign when coupled with a declining SP500.

My issue with using current unemployment rates is that they are so, well, weird. We have 3.6% unemployment but there are 11 mil jobs that can't be filled and folks still being paid because they "can't find work."

My gut tells me we can go from "hey, everything is fine" to "oh cwap!" in just a month or two when it all hits the fan. No crystal ball involved here - it just seem so strange right now. YMMV

 

[SecondCor521]

My issue with using current unemployment rates is that they are so, well, weird. We have 3.6% unemployment but there are 11 mil jobs that can't be filled and folks still being paid because they "can't find work."

I wonder about it as well.

Some of it may be skills gaps - an unemployed welder might not be able to get hired as a bank lending officer.

Some of it may be location gaps - an unemployed person in Ohio might not be able to relocate for a job in South Dakota.

That's probably not all or even most of it though.

There are still loads and loads of ~$15/hour entry level jobs around here.

 

[Koolau]

I wonder about it as well.

Some of it may be skills gaps - an unemployed welder might not be able to get hired as a bank lending officer.

Some of it may be location gaps - an unemployed person in Ohio might not be able to relocate for a job in South Dakota.

That's probably not all or even most of it though.

There are still loads and loads of ~$15/hour entry level jobs around here.

Very likely you are correct. I actually think there could be an element of folks "waiting" to see what happens post Covid. Some folks have gotten used to helicopter money and living in mom's basement - why work? Hard to really say what's going on which is why it seems "weird" to me but YMMV.