Hey There Income Hunter,
Welcome to the second coming of the Federal Reserve’s quantitative tightening cycle!
Here is the lowdown on how QT will work:
- The first phase of the cycle will last three months, with the Fed removing $47.5 billion a month, including $30 billion in Treasuries and $17.5 billion mortgage securities.
- The second phase, beginning in September, will increase the amount to $95 billion a month ($60 billion in Treasuries and $35 billion in mortgages).
All told, the Fed plans to remove $1 trillion from the banking system.
However, it is critical to realize that the Fed is initiating an aggressive tightening policy into a rapidly slowing economy and …
Today, I want to reveal the real longer-term damage QT will have on the markets …
Banks Must Do Heavy Lifting
The illustration below shows the process for draining liquidity from the markets. The Fed’s FOMC trading desks call around to all the banks and request bids for the bonds they are selling that day. The Fed responds to the best prices and confirms all purchases. The banks can then hold bonds on their balance sheet or sell them into the market.
The Fed will have a much tougher time selling US Treasury bonds then they have had in the past for a couple of reasons:
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The market for US bonds has shrunk, as foreign buyers lost confidence in the government and the Fed. That was spurred on when the dollar was weaponized via recent sanctions.
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An inflation rate well above the interest rate on bonds creates a negative yielding return for investors, which is a demand destroyer.
The Banks are in an even tougher position to take on much more debt because 27% of their assets are US Treasury and mortgage bonds already.
This process will have a major impact on the markets …
I believe the combination of inflation and the Fed’s QT policy guarantees that the 40 year bull market in bonds is over.
QT will also have a negative impact on bank profit margins. They will be holding a depreciating asset. The longer the inflation rate remains above the rate of return on the bonds, the worse it will get for banks.
The SPDR Select Sector Bank ETF (XLF) dropped yesterday, and the higher rates on bonds will also weigh on the Tech sector.
Bring It Home
These next two months are critical in terms of economic data.
The consumer is tapped out. Their wages after inflation are trending lower as costs for goods are trending higher.
Credit cards are maxed out and the average savings rate is now below 5%.
And now we get to deal with an aggressive tightening cycle.
We should be thankful we are traders and can front-run the Fed’s poor decisions.
Stay tuned for more insight and as always …
Live and Trade With Passion My Friend,
Griff