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The Federal Reserve is Still Not as Accommodating as Many Think


Chief Strategist at Interactive Brokers

Markets are in motion this morning.  For the first time in years, the Federal Reserve put limitations on banks’ ability to increase dividends and buyback shares and the worsening Covid-19 outbreak is forcing Texas to roll back its re-opening plans.  None of this is good news, and it looks worse because we have given back more than yesterday’s mysterious 1% rally in the final hour.  Yet a common narrative remains intact – the Federal Reserve remains accommodative.

Federal Reserve data once again forces me to question that narrative, however.  Last week I published a piece showing that the Fed’s balance sheet was no longer expanding.  In fact, it had contracted last week.  Using the data released by the Fed in their weekly H.4.1 report, released Thursday afternoons at 4:30 PM Eastern time, I updated the graph of the Federal Reserve balance sheet.  Guess what: while the decline was smaller than last week’s, the balance sheet shrank once again.

Federal Reserve Balance Sheet, Weekly Absolute and Percent Changes, and S&P 500

Federal Reserve Balance Sheet, Weekly Absolute and Percent Changes, and S&P 500

Source: Bloomberg

Please don’t be fooled by the upticks in the weekly change and percent change lines.  The values are still negative, just not as sharply negative as the prior week.  They still show a decline, just at a smaller pace.

I would rather focus on what people do, rather than what they say.  I especially prefer focusing on data than common narratives.  Yesterday’s data punctures much of the common narrative regarding the Fed’s accommodation.

That said, I do believe that the Federal Reserve remains generally market-friendly, though in the longer term rather than the short-term.  These slight declines notwithstanding, they have shown little inclination to shrink the balance sheet in a meaningful way.  I also have no reason to doubt that the Fed will be vigilant about acting aggressively if circumstances dictate.

That willingness to act is often termed the “Fed Put”.  It is somewhat of a misnomer.  A put option confers the right but not the obligation to sell the counterparty a specific security at a specific price at or before a specific date.  As of now, the Fed has never directly intervened in the equity markets, and while their commitment has no fixed end date, we also don’t know what degree of market sell-off would warrant Fed action.  In other words, we don’t know the striking price of the “Fed Put”.

The chart above shows that we saw declines to about 2500 on SPX before the Fed sprang into action.  The chart also shows that monetary policy typically has a 2-3 week lag before it affects equity prices, meaning that markets fell another 10% or so before arresting their decline. 

Investors must ask themselves whether they are positioned based on a narrative about Federal Reserve accommodation or because of the other fundamentals underlying those investments.  Furthermore, if investors are comforted by the notion of a “Fed Put”, they must as themselves where they believe that put is struck and whether it will provide them with sufficient protection in the case of a worsening market outlook.

Read more of Steve’s Thoughts on This Topic Here:

The Fed is No Longer as Accommodating as Many Think

Disclosure: Interactive Brokers

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