Jerome Powell confidently clung to the notion that, if re-appointed for a second term as Fed Chairman, he would proceed to increase interest rates at least four times and continue to reduce the amount of monthly stimulus being created on its balance sheet.
That was on January 11th during his testimony to the Senate Banking, Housing, and Urban Affairs Committee during the nomination hearing to re-elect him to a second term as Chairman of the Board of Governors of the Federal Reserve System.
Equity and crypto markets have, since that day, cratered and continue to demonstrate the characteristics of an intensifying bear market and could even be heading toward financial crisis.
This should come as no surprise to students of markets since this is exactly the outcome predicted by numerous commentators (including us), which is no great achievement of forecasting; this is precisely the market response to the last time the Fed communicated an intention to reduce stimulus and raise rates in 2013.
After the now infamous “taper tantrum” that saw major indices plunge lower after the mere suggestion by some Fed governors that the economy was ready for tapering in May 2013, and caused Bernanke to scuttle plans to reduce the then $85 billion in monthly bond purchases.
Fast forward to today, and we are faced with the prospect of the Fed further tapering stimulus from the current $105 billion per month to some as yet undermined level. The Fed reduced direct bond purchases from $120 billion to the current levels in December 2021.
The Fed set the reserve requirement for banks to hold of its deposits to zero percent in March 2020, which means that banks no longer need to hold any of its deposits in reserve, clearing the way for unlimited expansion of leverage into markets by borrowers.
This has been the principal driver of the valuation explosion in everything from homes to crypto to tech stocks to commodities.
It has created a zero-risk environment for investors in major US markets because the Fed’s $120 billion per month was fractionally banked out into at least $1.2 trillion per month, lent by Tier One banks commercial banks, and then on to borrowers from billion-dollar hedge funds to Joe Mainstreet who then wager it on tech stocks and cryptos.
Withdrawing this stimulus – or even threatening to downsize it – has the effect of creating a panic among investors who are now suddenly hugely incentivized to remove all at-risk capital from markets.
Therefore it stands to reason that the only way to stop the market from continuing to crash is for the Fed to announce a pause on its intentions to reduce stimulus or raise rates – both of which are pretty much a given, since we know that Fed prioritizes stock market gains far and above its mandated goals of stable inflation and full employment.
As I write this, the S&P 500 (INDEXSP: .INX) is off over 1,000 points or 2.9%, NASDAQ (INDEXNASDAQ: NDX) is down 4.9%, and the Dow (INDEXDJX: .DJI) is off 2.7 percent. Look for intermittent reversals to the upside as the unofficial US dollar support mechanisms of the US government seek to limit the carnage.
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