Stocks got a boost on Friday and gold rose 1.8% on further signs that the Federal Reserve is capitulating.
An article in the Wall Street Journal basically confirmed the Fed is now thinking about winding down its quantitative tightening program. As a CNBC headline put it, “The Fed may be moving closer to ending its rally-killing balance sheet reduction.” As Peter put it in a recent podcast, “The Federal Reserve is having to prematurely abort quantitative tightening, which is exactly what I said they were going to do before they shrunk the balance sheet by the first dollar.”
“Not too long ago, it was on autopilot, they were just going to leave it alone and it was going to keep on going and then the market started to cave and then they change that to, well, we’re data dependent and now the market starts to go down a little bit more and all of a sudden we’re almost done.”
Peter said the central bank was never going to be able to significantly shrink its balance sheet.
“I said before they made any significant progress in reducing that balance sheet they would have to stop. And that is exactly what they did.”
The Fed began the balance sheet roll-off in October 2017. At that point, it had grown to $4.5 trillion after three rounds of quantitative easing.
The Federal Reserve hasn’t actually been selling off bonds. It has simply allowed the proceeds from mature bonds to roll off instead of reinvesting them. According to CNBC, “The maximum roll-off is $50 billion a month, though it is rarely, if ever reached — December saw about a $34 billion reduction in the Treasurys and mortgage-backed securities that are involved in the program.”
The Fed has reportedly shrunk its balance sheet by about $400 billion. That sounds like a lot until you put it in the context of $4.5 trillion. The markets have not responded well even to this modest tightening. As CNBC put it, “While Fed officials initially thought the balance sheet reduction could be done with little disturbance to markets, that hasn’t been the case.”
Peter said he’s now two-for-two in predicting how Fed policy would evolve. He not only said the central bank wouldn’t be able to significantly tighten, he also said if it did try to raise interest rates, it wouldn’t be able to complete the journey to “normal.”
“So, they’ve stopped raising interest rates and they’re going to stop quantitative tightening. Exactly what I said they were going to do.”
Of course, knowing that the easy money punch bowl isn’t going away makes stock market investors happy. But as Peter said, they don’t seem to understand this was inevitable because the Fed didn’t solve any of the problems that led to the 2008 financial crisis. They made all the problems bigger.
“I knew from the beginning if they tried to normalize rates they would prick their own bubble. If they tried to shrink their balance sheet, they would be trying to pull the table out from under the cloth. And I knew that was an impossible trick. Well, now the Fed had figured out that it’s an impossible trick. But it’s not just stopping midway. They need to shove the rest of that table back under that cloth, because otherwise, it’s still going to collapse.”
But Peter said at this point, it doesn’t really matter. The bubble is pricked. The air is coming out no matter what the Fed does now. And he’s been saying all along that the Fed won’t be able to stop with ending its tightening program. That’s just a stop on the way back to zero percent interest rates and another round of QE.
“The bear market started and the Fed was scared, and they did exactly what I said they were going to do and they reversed policy.”
Peter said he expected the Fed’s initial capitulation would spark a brief relief rally. That’s where we are now.
“But this rally is going to run its course. This is a bear market rally. This is not enough. The rate hikes of the past have already ensured a recession. The fact that the Fed is no longer expanding its balance sheet ensures the recession. They needed to continue quantitative easing, and without it everything is imploding. It just didn’t implode right away. There is a lag between this monetary policy and the unraveling of this bubble that inflated on top of this policy. But now it is all coming unglued, and what is going to happen is when the market goes back down and takes out the lows, or even just gets in the vicinity of the lows, and as we get some more bad economic data, then the Fed is going to cut rates. Then the Fed is going to launch quantitative easing. Or they’re going to wait until we’re actually in a recession to do that. But that is the next thing that is going to happen.”
Simply put – this is just the first piece of the puzzle.
Peter said right now, we have an opportunity to increase our exposure to gold and silver, and decrease our exposure to the dollar and US stocks.