Let's take note of the status of financial system liquidity here at the outset of what is, in
prospect, another susbstantial round of money printing by the Federal Reserve.
My broad measure of financial liquidity is up a scant 4.5% over the prior two years. Of that
increase, 80% comes from a rise in currency and checkables. So, quantitative easing by the
Fed accounts for the vast bulk of the paltry gain in the total. Bank funding growth has been
sharply curbed by a nearly $1 tril. run-off in private sector shorter term credit demand and
there has been an outright $700 bil. collapse in the market for asset backed and finance co.
commercial paper. This degree of liquidation is unprecedented in the modern era.
The Fed waited through most of 2010 to see if a a rather moderate economic recovery
would trigger a rebound in private sector credit demand. It did not, and the Fed, concerned
about the sustainability of the recovery, opted to begin another large ($600 bil.) program
of quantitative easing to assure a significant measure of funding for the economy.
Whether they will actually need to buy the $600 bil. of Treasuries is an open question in
my book. The weekly leading indicators suggest the economy is set to regain faster growth
traction and if this occurs and credit demand responds in a more positive, normal fashion,
the Fed will have the option to consider slowing the printing press as credit demand takes
on its accustomed role in helping to drive the economy. If private sector caution continues
and households and businesses refrain from borrowing more, than the Fed will proceed
with its program through mid-2011. It will be up to the Fed to tackle the issue of finding
the "right" balance.
The stock market has been keenly cognizant of Fed balance sheet mangement activity over
the past 18 odd months. The last three substantial downdrafts in the stock market -- early
2009, mid 2009, and spring 2010 have all occurred during periods when the Fed was
temporarily shrinking its balance sheet. Likewise, the bull moves in the market over this
period have come when the Fed has been expanding its balance sheet, or has been
promising to. When credit demand is shrinking or is flat, investors know that the Fed is
the only game in town when it comes to providing liquidity to the system. In this regard,
I suspect that if credit demand does pick up, then equities players will become a little
less sensitive to the ups and downs of the Fed's balance sheet.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!