The growth of monetary liquidity has been shrinking until recently. The shrinkage was severe
enough to force the US economy to rely on private sector funding to underwrite growth. Recently,
the Fed has backed away from its policy of strong liquidity tightening, which was adopted to
reduce the mammoth increase in the size of the Fed's balance sheet (Fed Credit) and the flip side
swelling of excess bank reserves. Fed Credit is still so large as to represent a major long term
inflation threat, but with the economy slowing down to a crawl, the Fed has decided to relent for
now. Liquidity growth is improving, but only mildly so, and is not yet nearly strong enough to
support more than a very mild resumption of economic and profits growth. Faster monetary
liquidity growth now seems inadequate to fund both improved economic growth and sustainable
rallies in the capital markets.
The Fed is clearly leaning toward reducing short term interest rates before too long, but take
note that Wall Street is particularly bad at guessing Fed intent. If the Fed moves to cut rates
in the weeks and months ahead, there could be an additional shot of liquidity to the system as
as the Fed moves to assure an orderly transition to a lower rate structure. In this event, stocks
could receive an additional mild positive jolt.
On the other parched palm, if the Fed opts to toss caution to the wind and run with a more
liberal policy, the US Dollar will sink in value and the long dormant commodities market will
likely perk up. The gold price would receive a nice boost while the bond market could weaken
sharply, leading to a return to a distinctly positive yield curve that would no doubt surprise
The performance of the US economy in 2019 has been dicey and it is not clear now whether
an easing of the monetary reins will be sufficient to assure that the US economy will firm up
enough to satisfy expectations built in to the new, lofty level of share prices. Such may well
be the case if the Fed keeps liquidity growth mild and does not open the tap as it might if a
full fledged recession needed to be tackled.
- 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 !!!