Fed Strikes A Strong Note As Expected

The latest data on the Fed’s balance sheet was released on Thursday afternoon.  And the balance sheet expanded appreciably as was widely expected heading into the week.

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Overall, the Fed’s balance sheet increased by $57 billion to $2.919 trillion for the week ended December 12.  This marks a continuation of the oscillating upward trend in the Fed’s balance sheet since the launch of QE3 back in mid September.

As was expected, the primary driver of the increase in the Fed’s balance sheet was the settlement of a major tranche of mortgage-backed securities (MBS) purchases scheduled for December 12.  This alone led to a net $45 billion increase in the Fed’s balance sheet over the past week.

The increase in the Fed’s balance sheet is likely to continue over the next two week, albeit at a more measured pace, as a round of 15-Year Fannie Mae and Freddie Mac MBS purchases are set for settlement on Tuesday and a block of 30-Yeaer Ginnie Mae bonds are slated for next Thursday.

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Whether these latest liquidity injections translate into stock market gains remains to be seen.  But even though the initial response has certainly been lackluster, it is worth noting that recently favorable technical support readings remain fully in tact despite today’s pullback.  For example, stocks as measured by the S&P 500 Index (SPY) are holding newly established support at the 50-day moving average.  Moreover, stocks remain in bullish territory according to its Relative Strength Index and momentum continues to move in a positive direction.  Thus, stocks may still show the power to move higher in the coming days despite Thursday’s disappointing price performance.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Conducting Bernanke’s Symphony No. 3 In F Major

The Fed’s QE3 stimulus program has taken on a clearly distinct rhythm.  Thus far, the liquidity injections into the financial system thus far have come on a selected few strong notes that have occurred roughly every four weeks.  And following this 4/4 meter of the Fed’s newest monetary policy symphony, the next major injection is set to burst into the market starting next week.

Since the launch of QE3 back in mid September, the Fed’s balance sheet has been trending higher.  But it has been doing so with much vibrato.

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This variation in the movement of the Fed’s balance sheet can be explained by composition of the assets being purchased as part of the program.  QE3, at least to this point, is exclusively focused on the purchase of mortgage-backed securities (MBS) at a rate of $40 billion per month.  And although the Fed commenced the purchase of MBS immediately following their September 13 policy announcement, the settlement of these purchases are often delayed by several weeks to a few months.  For example, while the Fed committed to purchase a block of MBS securities totalling $950 million on September 14, which was the first day that QE3 was put into action, this trade is not scheduled to settle until next week.  Thus, it will have taken a full three months for the MBS securities to be exchanged for cash in this instance.

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Overall, these settlements occur on a few specific dates each month, which helps explain the rhythmic pattern of the Fed’s balance sheet expansion thus far.  The last major MBS settlement block occurred on November 14 for 30-Year Term Fannie Mae and Freddie Mac securities and was followed by two smaller MBS settlement blocks on November 19 for 15-Year Term Fannie Mae and Freddie Mac securities and November 20 for 30-Year Term Ginnie Mae securities.  This helps explain the big liquidity burst during the week at the front of the latest meter followed by a second smaller increase the following week.

Looking ahead, the next major rush of Fed liquidity from MBS purchases is set to arrive starting next week.  The three major settlement dates for December are December 12 for 30-Year MBS, December 18 for 15-Year MBS and December 20 for 30-Year GNMA.  The asset totals for these upcoming settlements are already confirmed to be at least $44.25 billion, $12.65 billion and $13.95 billion, respectively, and could reasonably come in around $54 billion, $16 billion and $17 billion, respectively, if not more once the final operational results are revealed by the Federal Reserve Bank of New York on December 13.  This suggests that the amplitude of the MBS purchases at the beginning of each 4/4 meter is only set to increase with each passing month, as the preliminary estimates for December totaling $87 billion are more than 50% higher than November’s totals.

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What implications if any does this have for stocks?  If recent history is any guide, it may have an increasingly notable impact.  When the Fed’s first QE3 injection found its way into markets in mid October, the stock market as measured by the S&P 500 (SPY) increased by +3%.  And when the second larger round of liquidity flowed into the system in mid November, stocks advanced a more pronounced +6% and managed to break back above critical resistance at the 200-day moving average in the process.

So what might we expected from stocks with the next wave of liquidity set to arrive next week?  Clearly, these forces will be placing meaningful upward pressure on stock prices.  Thus, an even more robust advance is possible over the coming weeks, but such an outcome will depend on the various other macroeconomic, political and market forces also at work in the markets along the way.  Most significantly, events surrounding the fiscal cliff including reaching a compromise solution could easily send stocks on wild and unpredictable swings at any moment in time.  But all else held equal, these monetary stimulus induced forces are likely to provide a steady tailwind for stocks as we move through the next two weeks.

The Fed’s latest symphony is likely to remain in its current 4/4 meter as the first movement plays out through the end of the year.  But as we move into 2013, do not be surprised if the second movement of the Fed’s score takes on a notably quicker tempo.  For once outright U.S. Treasury purchases are added to the composition as expected, the Fed may be striking a particularly strong note with liquidity injections each and every week.  And while this has the potential to help send stocks euphorically floating higher over the coming months, the key of the Fed’ symphony in F Major hints at what may befall the U.S. economy and its markets once the music of Bernanke’s latest opus finally comes to an end over the next 12 to 18 months.  And this final end game outcome will be particularly worth listening to once it finally arrives.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Fed Balance Sheet Shrinks

The expansion of the Fed’s balance sheet took a step back this past week.  According to the latest balance sheet data released by the U.S. Federal Reserve for the week ended November 28, 2012, the Fed’s balance sheet actually contracted fairly sharply by -$19.8 billion to $2.853 trillion.  As a result, since the beginning of QE3 in mid-September, we have now seen a net increase in the Fed’s balance sheet to date of just +$27.7 billion.

So from where did the decline originate this past week?  Ironically, it came almost exclusively from the one line item that is supposed to be increasing at a rate of $40 billion per month under QE3.  During the past week, the Fed showed a net decline of -$17 billion in Mortgage-Backed Securities.  And this occurred despite the fact that the Fed through its Open Market Trading Desk at the Federal Reserve Bank of New York carried out $16.9 billion in gross purchases of MBS securities over the past week.

 

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As has been discussed in past articles, the reason for the disconnect between Fed MBS purchases and its balance sheet expansion to date is due in large part to the nature in which MBS securities trade.  They have long periods until settlement and tend to come through the system in big chunks all at the same time.  This has certainly been true thus far with QE3.  Also, the Fed also continues to hold MBS securities from past purchase programs that are either being called or are reaching maturity, which is also dragging on the pace of the Fed’s balance sheet expansion.

But as each week passes, an increasing reservoir of liquidity is building behind the Fed dam.  To date, the Fed has made net purchases of $184.0 billion in MBS securities, yet a net increase of only $39.8 billion is currently reflected on the Fed’s balance sheet.  In other words, only 20% of the Fed’s MBS purchases to date have even started to make their way through the financial system. 

As the Fed continues to purchase MBS securities each week at an average rate of $17.4 billion per week, the liquidity flood waters will only continue to silently build behind.  And as the flood gates increasingly open and this liquidity flows into the financial system, the impact on stocks (SPY), high yield bonds (HYG) and precious metals including gold (PHYS) and silver (PSLV) is likely to become only more pronounced.

Disclosure: I am long HYG and both gold and silver through the Central GoldTrust (GTU) and the Central Fund of Canada (CEF), which holds a 55% gold to 45% silver allocation.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

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