Watch *This* DANGER when the Fed Runoff STARTS.

hey everyone we kevin here with cpi

inflation data coming in at seven

percent year over year the highest since

1982 folks are now wondering is this the

potential start to a recession and is a

balance sheet runoff from the federal

reserve going to make things worse

consider this since 1914 there have been

12 cycles or cyclical instances where

headline inflation has risen above 5

right now being one of them of the prior

11 times

eight of them coincided with the onset

of recession that means 72

of the time we had inflation above 5

in a cyclical period

a recession

followed

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shortly but we gotta talk about the

potential for the federal reserve's

tightening

to be an issue or will tightening end up

being a nothing burger remember folks

the federal reserve tightening is

removing liquidity from the market and

when the federal reserve removes

liquidity from the market we think that

means there's less liquidity available

for business borrowing investing into

the stock market investing into

cryptocurrencies or other risk-based

assets and so what ends up happening

potentially those valuations come down

especially since we already know that

valuations are pretty richly elevated

right now especially by you know

comparing to standards of history and we

look at price to earnings ratios now

compared to the past and we're at

relative highs which means we could

endure some kind of stock market shock

in fact that's kind of what we've been

seeing for the last six weeks has been a

lot of negativity in the market and a

lot of convictionless rallies but folks

bill dudley in bloomberg's opinion

section today put together a very

detailed piece on why he actually

believes the federal reserve's

tightening

might actually be a big old and nothing

burger he suggests that while there are

going to be similarities between 2017

and now there are a lot of differences

and we've got to consider those when we

wonder will the market crash because of

the federal reserve's tightening so

let's go down this analysis first

our economic outlook today is actually

much stronger than economic outlook was

in 2017.

we also have substantially larger

holdings at the federal reserve which

means every little bit of running off of

the balance sheet is a smaller

percentage of the overall portfolio that

they're holding

and the bonds they have are shorter and

average maturity which means the feds

kind of got to get rid of those anyway

but let's compare a little bit more to

2017 and then see what kind of

conclusions we can draw here because

right now a lot of people are worried

about that vacuum cleaner of the federal

reserve sucking up excess money right

during the last economic expansion the

transition through the stages of

monetary policy normalization aka trying

to go to some level of normal where

rates are stable and the fed's not

printing money or taking money out of

the system during the last expansion

this process was very very slow the

federal reserve began increasing rates

somewhere at the end of 2016

and they didn't really start tapering

until three years

after they finished printing money this

time around we expect asset purchases to

stop in march and a potential unwinding

of the balance sheet as soon as july at

least that's what goldman sachs expects

jp morgan has a similar expectation that

means we might only be waiting two to

three months before starting to unwind

the fed's balance sheet right now

compared to the three years we waited

the last time around

on top of that the last time we had

quantitative tightening we ended up

having turmoil in the stock market

remember the end of 2018 or even the

beginning of 2018 stock market was not

very happy when the federal reserve was

sucking up money from out of the market

they started sucking up money from out

of the market the beginning of 2018 and

that continued throughout the tooth uh

throughout 2018 which led to a very

brutal stock market in 2018 and a lot of

folks think that 2020 could end up

looking like 2018 where we go into the

year with a seven to eight percent

selloff and we end the year with another

21 sell-off

well folks let's understand the repo

market because this folks

might actually end up making

quantitative tightening a complete

nothing burger so first things first

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federal reserve has

such a large balance sheet that what the

federal reserve is going to expect to do

is sell bonds to the market treasury

bonds and mortgage-backed securities who

buys these well sovereign funds uh

sovereign institutions who need to

park their money into relatively safe

debt from other countries we'll buy our

bonds

people often wonder like who's paying

who's buying a bond to get a 1.5 yield

well if you compare to the rest of the

world if an institutional investor in

canada wanted to invest in a relatively

risk-free bond they're probably getting

negative yields in europe they're

getting negative yields in japan

they've got a lot of risk investing in

bonds in china or even inflationary

regions like south america specifically

brazil experiencing over 10 inflation or

look at the turkish lira which has lost

a third of its value relatively quickly

over the last few months

there are a lot of risks investing in

other assets

and so

the united states bond market team seems

to be relatively desirable for folks to

go shopping

for relatively safe debt in uh to park

their money in so that way they're not

you losing money it's almost like

they're parking money to break even but

where is this money going to come from

well the reverse repo market can give us

a little bit of an idea so if we go

ahead and jump on over to google right

now and we do a quick search for the

reverse reaper market we'll type in st

louis fed reverse reaper market this

represents the amount of deposits from

banks and institutions at the federal

reserve and this oftentimes signifies

excess cash that banks have above and

beyond money market funds and other

requirements take a look at this folks

this is the federal reserve's reverse

repo

operation it has exploded in the amount

of money that is accepted on an

overnight basis and the federal reserve

uh or i'm sorry bloomberg put together

this particular piece which gives us a

little bit of insight into maybe what we

might be up against so take a look at

this on the left side you see the first

gray line and this indicates the start

to

reducing bond purchases or eliminating

bond purchases rather and finally

starting to run off the balance sheet

you'll notice at the top it says rrp

facility that's the reverse repo

facility

and as

we expect to increase the fed funds rate

and start reducing the federal reserve's

balance sheet

we might actually start

running off the reverse repo facility

first and this actually means that we

probably won't be dipping into bank

reserves until all the way through

august of 2023 which is when we'll

actually start seeing tightening because

remember this folks we're not really

tightening if we're just taking money

away that nobody needs right now anyway

this money at the reverse repo facility

could be money that's just sitting there

that banks don't need and they're not

even lending out when you have

tightening it's when you actually start

removing money from our institutions and

our banks and that's what's so

interesting is if we build this sort of

foundation here let's say and we built

this bottom portion up over here with uh

minimum money that banks need so we'll

just right here that's the minimum

amount of money the banks need this is

the extra money that banks have right

here so this is the extra

well we could go over here and fill in

the top section here and call this over

here more than extra

more

than

extra so this is the minimum they need

to operate this is really the extra

stuff that they can lend out to

businesses and this is just the level of

ridiculousness well the reverse repo

market right now has 1.527 trillion

dollars in it the federal reserve is

expecting to probably

like run off up to about 90 billion

dollars per month of assets

1.527 divided by 90 works out to about a

17-month cycle before we completely burn

this entire extra section over here so

before this extra section is just erased

like this

it's going to be about 17 months

then you actually get into the

tightening phase where you start coming

in here and you start shaving off the

top over here

so in other words because of how long

it's going to take for the federal

reserve to actually tighten and how

they're probably only going to tighten

to the tune of about 90 billion dollars

per month they're not actually or

effectively going to tighten until

august of 2023 which means right now

markets are potentially in this element

of peak fear because oh no the

tightening is coming oh no rates are

going to go up but wait a minute we've

got so much freaking money that the

markets right now might actually be

overpricing the level of fear and drama

that is going to come in the future in

fact i drew this chart that i think

gives us a really really good uh

explanation visually of of how the

market seems to be acting let's say this

red line right here let's say this

represents fear in the markets and let's

say this and this is already realized

fear so we've seen fear go up recently

right

let's then come over here and say this

dotted line right here

represents fear to come so in other

words fear that hasn't happened yet but

the market's belief that more fear is

coming

it would appear to me that the market

thinks we're going to be at peak fear

sometime when we have rate hikes start

and a runoff of the federal reserve's

money in other words uh may comes around

the federal reserve says we're raising

rates and we're taking money out of the

system it seems like right now the stock

market is pricing in the worst case

scenario that

when those rates go up and when the

federal reserve starts sucking up money

the market's gonna be really pissed and

the market's gonna sell off

but the market is pricing that in now

and so when as usual when the market

prices things in early in my opinion

it's a sign that we're probably actually

going to have a decline in fear marked

by this orange line that we might still

have fear to go in this market but that

this fear might rotate down

substantially and ironically we might

end up being at a point where we're in

substantially lower fear or a lower fear

environment come march to may

than what the market is pricing in right

now because of the fear of these rate

hikes and runoffs peaking uh or creating

peak fear in march through may now no

guarantees that's just the theory but

when we combine this theory with the

argument that wait a minute

we're when we actually begin the runoff

we're not

really

tightening for another 17 freaking

months that's crazy that we're not

actually going to be tightening for

another 17 months which means again

we're not actually taking money out of

the system for that long and this makes

sense now because if we look at what the

fed says they say they want to foster a

very expansionary policy for the next

decade

to make sure that they can get

individuals to max employment

participation talked about this

yesterday that the federal reserve just

needs to clean up the mess of inflation

raise rates to deal with inflation but

don't

run off the balance sheet so heavily or

raise rates so extremely that we now

push our economy into recession that

would be the worst case scenario because

it would go counter to what the federal

reserve is trying to do which is get

more people in the workforce more

businesses growing more labor force

participation and max employment which

includes having equal employment amongst

all different races which right now

there are substantial disparities in in

fact black unemployment is as high as it

was back in the 1950s which is kind of

insane if you think about what our world

was like 70 years ago compared today

but anyway uh this this fed runoff in my

opinion is potentially very very bullish

and it's being

overblown by markets right now we even

even had loretta mester just this

morning say they don't want to bring

markets down with a balance sheet

reduction they don't want to royal

markets they want to give markets the

confidence that the federal reserve is

going to respond to inflation which

they've been slow to respond to and

whatever

bond runoff we end up end up actually

having would be at such a level that we

don't end up shocking the market that's

what we're being told right now might

not believe this might still be an

opportunity to hedge and be careful in

fact the market is relatively mixed

right now on a typical convictionless

sort of rally that we had this morning

but i will say not having that

tightening really take effect until

august big thing again

watch this chart right here the reverse

repos chart you're going to watch this

repo chart go down substantially over

the next year and a half

and when this chart goes to zero

maybe that's when we actually start

experiencing tightening but until then

it's actually a lot of liquidity in the

system and it doesn't look like it's

going anywhere all right folks thank you

so much for watching this video

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in the next one thanks again bye