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The press conference that could shake the markets


After falling almost 20% in the last quarter of 2018, the markets rose about 13.34%, with the prospect of two or more interest rebates this year.

The other influence on the resurgence of stock markets and the return of activity to the high-yielding debt markets that froze last year has been indications that the Fed is reconsidering its earlier position that its planned reduction in the size of its balance sheet would remain in the automatic pilot. at least for the next three or four years.

Former Fed chairman Janet Yellen, in unveiling the plan to reduce the size of the balance sheet, said it should be like "watching dry ink."

The Fed's balance sheet was swollen by its three post-crisis programs of "quantitative easing" – Treasury bonds and mortgages.

The size of its balance sheet expanded dramatically from $ 900 billion to $ 4.5 trillion in its peak when the Fed resorted to unconventional monetary policies after exhausting the more conventional response by reducing US official rates to zero.

Since October 2017, the Fed has shrunk its balance sheet, initially at a rate of $ 10 billion a month in a program that hit its projected ceiling of $ 50 billion a month last October.

This coincided with the worst of the stock market implosion, prompting Donald Trump to tweet that the Fed should "stop with 50 B's."

QE programs have injected large amounts of cheap liquidity into the US banking system, reducing long-term interest rates and forcing investors to take increasing risks for positive but decreasing returns.

With similar actions by the European Central Bank and the Bank of Japan, Fed policies were the basis of one of the biggest bullish markets in history – and a large accumulation of global debt.

President Donald Trump speaks at the White House Rose Garden, Friday, January 25, 2019 in Washington. (AP Photo / Jacquelyn Martin)

President Donald Trump speaks at the White House Rose Garden, Friday, January 25, 2019 in Washington. (AP Photo / Jacquelyn Martin)Credit:JACQUELYN MARTIN

The steady withdrawal of this liquidity and the buying support that the Fed provided for US Treasuries and mortgages, even with the US government loan program firing as the US deficit, exacerbated by tax cuts and spending of Trump, exceeds $ 1 trillion. means less liquidity and higher US interest rates.

If the QE dramatically inflated all risk assets, then the QT – quantitative tightening – should empty them.

Many would argue that the normalization of US monetary policy and the normalization of risk pricing for financial and real assets – more than a decade after the crisis – would be a healthy development.

Those with large exposures to these inflated asset markets and highly expanded debt markets, however, would disagree, and the Fed's response to the market turmoil last year suggests that markets are not for the first time influencing their thinking.


By mid-December, Powell still asserted that the Fed's balance sheet strategy would not change. Earlier this month, however, he said the Fed "would not hesitate" to adjust the program if it starts to cause problems in the markets.

If there is an "adjustment," it probably will not be the rate at which the Fed reinvests the proceeds of overdue securities and mortgages. More likely to be some indication of when the program ends.

As the Fed's balance sheet shrank, Fed governors did not provide a deadline for the program or a target for eventual size of the balance sheet.

No one expected, or expects the balance sheet to retreat to its $ 900 billion threshold. The liability side of its balance sheet, defined by global demand for US dollars and cash within the banking system, also expanded.

There was initial consensus that it would take four or five years to normalize the Fed's balance sheet and would end up with assets ranging between $ 1.5 trillion and $ 3 trillion. Today, it has about $ 4 trillion in assets.

More recently, there has been considerable debate about the normal level of liquidity in a US financial system that has changed significantly since the pre-crisis era, not because of the global regulatory response to the crisis and the new regulatory regime. was imposed on bank liquidity requirements, which block the bank reserves that could be available for loans.

The Fed could pause, or reduce the scale, the purchase of securities or could indicate an end point for the program that would leave its balance sheet larger than previously predicted.

Either or both would be positive for financial markets, which is why anything Powell says about the program at his post-meeting press conference, and the language used by the Fed in its more formal post-meeting statement, have potential to move markets violently and in any direction.

Stephen is one of the most respected business journalists in Australia. He was most recently co-founder and associate editor of Business Spectator and an associate editor and senior columnist for The Australian.

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