The first phase policy error took place when the Fed foolishly doubled their balance sheet during the pandemic from $4.5 trillion to $9 trillion. The equivalent of 200 years of monetary largesse unleashed in one year. That unprecedented amount of monetary dopium found its way into every asset market on the planet from the housing market to junk IPOs/SPACs, Ark ETFs, Crypto Ponzi schemes, Reddit pump and dumps and most recently mega cap Tech stocks - What today's pundits are calling the "Magnificent Seven". Seven massively overvalued Tech stocks that account for all year-to-date market gains. Up until very recently, the Fed has been way behind the curve soaking up this excess liquidity. But now they are making up for lost time.
The second order policy error was keeping interest rates at 0% for far too long even as inflation was already soaring. During 2022, the Fed made up for lost time by increasing the Fed rate 3x what it was prior to the pandemic. From 1.5% to 5%. That was policy error number three - panic rate hiking after being asleep at the wheel.
By over-raising rates, the Fed committed a massive policy error, due to the policy mismatch of over-tightening on rates while under-tightening on the balance sheet. Meaning it was easy to issue junk bonds, but increasingly difficult for consumers to get access to credit. That Fed policy divergence is now collapsing the middle class. Below we see that homebuilders held up well during the rate hiking cycle. However, the 30 year long bond yield which is in the lower pane, has sky-rocketed since the Fed paused. This has caused homebuilders to collapse. The market is signaling that the Fed should pause quantitative tightening - balance sheet rolloff. However, the Fed plans to continue "normalizing" their balance sheet for several years.
Which means that we are now in the fourth and final Fed policy error. During Powell's interview today he said that the long bond collapse (yield spike) is now doing the Fed's job for them. Indeed, and then some. As I remarked above, the Fed had been far too slow reducing their balance sheet. However, at this late juncture, the bond market is now bidless. While I was watching Bloomberg Asia on Tuesday night, Rishaad Salamat was asking his guest market analyst if "we are all just waiting for something to break". She agreed - The Fed, Wall Street, investors, Zerohedge, are all desperately waiting for markets to break because then as the story goes the Fed can come to their rescue. It's the exploding market bailout hypothesis. Needless to say it has a dubious set of believers and an even more dubious chance of working.
The problem lies in what I said above - policy error #2 - the Fed has over-tightened on the middle class. It's far too late to seamlessly pivot to a bailout stance to avoid recession. This chart shows that in all three most recent instances, bank tightening of this current magnitude preceded recession. And, all three times, the Fed was already easing. But not this time.
This time, will be the "soft landing".
In summary, last October investors made a big bet on a Fed pause, which took almost an entire year to become reality.
Now, they are betting on a Fed bailout. Which will come far too late to save anyone who believes in it.
Unless, they're just a slack jawed pundit with no skin in the game.
