Do not mistake outcomes for control – remember, there is no such thing as control – there are only probabilities. – Christopher Cole, Artemis Capital
Central Banks globally have created a massive fiat currency fueled asset bubble. Stock markets are the largest of these bubbles – a bubble made worse by the Fed’s attempt to harness the “power” of HFT-driven algo trading. At least for now, the Fed can “control” the stock market by pushing the buttons that unleash hedge fund black box momentum-chasing and retail ETF buy orders whenever the market is about to head south quickly.
However, the ability to push the stock market higher without a statistically meaningful correction is a statistical “tail-event” in and of itself. The probability that the Fed can continue to control the market like this becomes infinitesimally small. The market becomes like a like a coiled spring. The laws of probability tell us this “spring” is pointing down.
The Fed announced in no uncertain terms that it was going to begin “normalizing” – whatever “normalize” means – its balance sheet beginning in October. Going back to 1955, the furthest back in time for which the data is readily accessible, the Fed Funds rate has averaged around 6%. But for the last 9 years, the Fed Funds rate has averaged near-zero. Back in May 2013 Ben Bernanke threatened the markets with his “taper” speech. More than four years later the Fed Funds rate is by far closer to near-zero than it is to the 62-year Fed Funds rate average. Can you imagine what would happen to the stock market if the Fed actually “normalized” its monetary policy by yanking the Fed Funds rate up to its 62-year average of 6%?
In September the Fed announced that it would begin reducing its balance sheet by $10 billion per month starting in October. Before the Fed began printing money unfettered in 2008, its balance sheet was approximately $900 billion. If we define “normalize” as reducing the Fed’s balance back down to $900 billion, it would take 30 years at $10 billion per month. But wait, the Fed’s balance sheet is going the wrong way. It has increased in October by $10 billion (at least thru the week ending October 18th). So much for normalizing.
The Fed is stuck. It has created its own financial Frankenstein. Neither can it continue hiking interest rates nor can it “normalize” its balance sheet without causing systemically adverse consequences. The laws of probability and randomness – both of which are closely intertwined – tell us that, at some point, the Fed will lose control of the system regardless of whether or not it decides to keep rates low and maintain the size, more or less, of its balance sheet.
Jason Burack invited me onto his Wall Street For Mainstreet podcast to discuss the Fed’s “Everything Bubble,” why the Fed can’t “normalize” its balance sheet and the unavoidable adverse consequences coming at the system: