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Affluent Investor | June 23, 2017

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Markets Say Tapering Is Tightening

Federal Reserve flickr

Wall Street Cheerleaders like to claim that the tapering of Fed asset purchases is not equivalent to the tightening of monetary policy. But the markets are clearly telling investors something different. Year to date the S&P 500 is down about 5%–not horrific for one month but certainly not following last year’s performance. But the economic data such as; durable goods, initial jobless claims, personal income, and housing sales have all shown a distinctive weakening trend.

The reason why tapering is tightening is because the Fed had been in the habit of taking away $1T worth of higher-yielding bank assets per year and offering them just .25% in return. Banks then needed to purchase a new asset such as: bonds, stocks or by creating a loan, which served to expand the money supply. However, going from $1T worth of asset purchases to $0 of QE, can hardly be offset by the amount of excess reserves held in the banking system. In other words, the banking system isn’t any more compelled to increase its asset holdings if the Fed’s balance sheet is $5 trillion than when it is $4 trillion. Believing otherwise represents a critical misunderstanding of the QE process and how the level of excess reserves influences the banking sector.

Nevertheless, the Fed continues to promulgate the fallacy that ending QE will not have an adverse effect on asset prices, money supply and the economy. And the majority of the investment public has accepted that nonsense as gospel truth. However, the global turmoil in equities and currency markets are great evidence that the reflation game has changed. Further proof of this is the fact that Treasury yields are falling into the teeth of the Fed’s taper of asset purchases. The only reason this counterintuitive trade would occur is if the market was convinced the overwhelming forces of deflation and recession are going to supersede the falling demand for bonds from the Fed.

The chaos in emerging markets is just one of the destructive ramifications resulting from subjecting the world’s reserve currency to 5 years of ZIRP and $3.3 trillion worth of money printing. Because of the Fed’s massive manipulation of interest rates and money supply, investors piled into emerging market countries searching for higher-yielding investments denominated in rising currencies. Those foreign central banks had to print local currency to keep it from appreciating too rapidly. That created inflation, which further exacerbated the move higher in asset prices.

Then, at the beginning of this year the Fed started to reduce the monthly amount of QE, forcing investors to panic out of E.M. currencies and equity markets and back into their domestic currencies. The currency market turmoil also forced those E.M. central bankers to raise interest rates to quell inflation and support their currencies.

For example, Turkey hiked its overnight borrowing rate to 8%, from 3.5%. Just imagine what would occur in the U.S. markets and economy if the Fed Funds rate was raised from 0%, to 4.5% in one day!

This is just one example of the unintended consequences resulting from governments’ efforts to bring the global economy out of the Great Recession by massively increasing debt levels and having that debt purchased by central banks.

To be clear, I turned bearish on the markets in 2014, precisely because of the implementation of the deficit-busting Affordable Care Act and the soaring interest rates and crumbling currencies in emerging market economies. Also, the Fed’s taper of QE (which will cause asset prices to tumble) and yet another debate and debacle regarding the debt ceiling. Expect global chaos this year to rival that of 2008, at least until the new Fed-head, Janet Yellen, re-institutes a protracted and substantial QE program.

Michael Pento is the President and Founder of Pento Portfolio Strategies (PPS). PPS is a Registered Investment Advisory Firm that provides money management services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular guest on CNBC, CNN, Bloomberg, FOX Business News and other international media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a Financial Columnist for Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.

Prior to starting PPS, Michael served as a senior economist and vice president of the managed products division of Euro Pacific Capital. There, he also led an external sales division that marketed their managed products to outside broker-dealers and registered investment advisors.

Additionally, Michael has worked at an investment advisory firm where he helped create ETFs and UITs that were sold throughout Wall Street. Earlier in his career he spent two years on the floor of the New York Stock Exchange. He has carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael Pento graduated from Rowan University in 1991.

  • William J. Holland

    Well written. I think its time for central bankers throughout first world political economies to “bite the bullet” and force politicos to face the very insurmountable fiscal/political challenges they sought to handover to the technocrats at the Fed. We’ve got plenty of intellectual architecture in Hayek & Von Mises for the job.

    A synoptic approach is what’s required. Don’t bet on Yellen to fix this one. Central banks have no traction on deflation & Keynesian thought won’t help either. Time for some very heavy fiscal lifting.

    Here’s the good news: the politicos at team Obama are intellectually lost here!

  • Without stimulus all would fail? Simply because we created this nightmare and got the entire world addicted to the “new economy” which really means false or fake or QE or Stimulus or whatever one may want to call it. ZIRP is of course a large part of the equation as well. So how do we get weaned back to what might be called a real economy not propped up by the illusions? It will not happen easily or willingly. There is no reasonable answer nor does anybody actually have a plan. It is likely guaranteed Yellen will only dig deeper holes of stimulus fraud. It is all far more complicated than saving the markets? those are already destroyed. It’s just that most people don’t quite grasp that part. It goes well beyond that concept and i imagine we will find out the hard way. Neither political team has a clue of what to do. If that were the case there would be no increased budget ad infinitum. And just how does anybody think we can grow ourselves out of our debt? With some new Appl devices or facebook or twitter or some other mindless distraction that produces nothing. At some point it simply won’t float anymore. Is technology really going to save us or is it simply sapping brain cells and creating ever greater illusions at this point? What a mess.

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