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Wall Street, investors, the media, and the public are hyper-focused on the Federal Reserve's rate hiking policy path, but the exact same trap door markets fell through in 2018 is about to open wide - and nobody's talking about it. Except me, that is.

That trap door is the Fed's quantitative tightening (QT) plan, the inverse of its bull market-friendly quantitative easing (QE) program. Starting this September, as in right now, the Fed's accelerating their QT operations, meaning the unwinding of their $9 trillion balance sheet.

Raising rates while simultaneously amping up QT will snap the stock market and the bond market. It happened in 2018 when the Fed began quantitative tightening. It's going to be different, meaning worse, this time.

But I'm not telling you this to ruin your day - quite the opposite, in fact. Because last time this happened, savvy players who were paying attention made a lot of money. And so can you - I'm talking a few hundred percent returns, potentially - during what's coming ahead.

Markets Tanked Last Time, They'll Tank This Time

Back in early 2017, the U.S. economy saw robust growth of 5.2%. Then, in 2018, the Fed began raising the federal funds rate - the interest rate big banks charge each other for overnight loans. The Federal Open Market Committee (FOMC) raised the fed funds rate by 25 basis points, lifting it to a target range of 1.5% to 1.75%.

They raised the target rate 25 bps again three more times at their meetings in June, September, and December, ultimately taking fed funds to a target range of 2.25% to 2.50% (which is exactly where fed funds rate is today).

In conjunction with raising rates, in May, 2018, the Fed announced they'd be starting quantitative tightening, shrinking their then-$4.441 trillion balance sheet by $95 billion a month.

The plan was to let $60 billion worth of Treasuries and $35 billion of agency mortgage-backed securities (MBS) a month "run off" the balance sheet. "Running off" means not replacing maturing bonds. See, for years, the Fed had been buying an equivalent amount of Treasury bills, notes, bonds, and MBSs that were constantly maturing out of their balance sheet.

What does that mean? Well, when the Fed isn't in the market as a buyer every month, other investors have to step up their buying. If those buyers don't step it up, bond issuers, (meaning the U.S. Treasury and mortgage securitizing banks), would have to raise the interest they offer investors to attract buyers.

And that is how the Fed uses quantitative tightening to push rates upwards along with their direct targeting of the fed funds rate.

In 2018, the Fed shrank its balance sheet by $385 billion. Higher rates and tighter economic conditions -- including liquidity issues in the all-important repo market -- upset markets. Frighteningly, from Oct. 1, 2018 to Christmas Eve., Dec. 24, 2018, the S&P 500 fell over 20% to end 2018 down more than 6%

That scared Fed Chairman Jerome Powell and the FOMC into an almost instant "pivot" in early January, to the extent that the Fed stopped QT altogether and began easing (meaning lowering rates) again.

That's the end of the history lesson. It's wasn't pretty then and it hasn't gotten any prettier in the last four years, so I'm not doing this just to take you down Memory Lane. I'm telling you this because the same patterns are playing out right now, as I write this.

Here's What's Coming Next

But, of course, flip on the television or read a paper, and you know the conditions on the ground today versus 2018 are very, very different.

• Back then, the economy was coming off of GDP growth of 5.2%. But today, GDP isn't growing, it's shrinking.
• Back then, inflation was running at a 2.49% clip. But today, inflation's running at 8.5%.
• Back then, the Fed's balance sheet was just north of $4.45 trillion. Today, it's just south of $9 trillion.
• Back then, the federal funds target rate got up to 2.25% - 2.50%. Today, it's starting there.
• Back then, with fed funds at 2.5%, the Fed stopped QT altogether. Now, with fed funds at 2.5%, the Fed's ramping up QT.

At the end of May this year, the Fed announced it would let $30 billion a month in Treasuries and $17.5 billion a month in MBS runoff its balance sheet for the next three months. This month, September, they're raising the monthly runoff to $60 billion a month for Treasuries and $35 billion a month for MBS.

At that pace, by the end of 2022 the Fed's balance sheet will be $522 billion lower. And bear in mind the 20% drop the market saw in 2018 was the result of higher rates and the Fed letting a similar amount runoff its balance sheet.

The Fed's hinted at reducing its balance sheet by $4 trillion, which about what it added since the start of the pandemic in 2020. So, imagine what a $4 trillion reduction in the Fed's balance sheet would do to markets if a $550 billion runoff caused a 20% drop in the S&P 500?

Imagine what fed funds going to 4.75-5.00% would do to markets if bumping them up to 2.5% in 2018 sent stock market benchmarks into correction and, for a while at least, into bear market mode? Rates are going higher and the Fed's balance sheet is going lower. That's a lose-lose situation for the stock market and the bond market.

So Here's How to Cash In on It

We're positioning ourselves, in my subscription services, for a bear market and a bond rout. To make a killing on the crashing bond market, we're "waterfalling" a trade we made earlier this year betting on rising rates and falling bond prices.

We traded an inverse exchange-traded fund, the ProShares UltraShort 20+ Year Treasury ETF (TBT), to rake in a 280% gain, then a whopping 800%, when rates started to rise. Waterfalling that trade means we're doing it again, only this time we're doubling down.

Buying TBT -- or like we're doing, the right calls or call spreads on TBT -- is what you might want to do as well, in order to bank some triple-digit gains from a bond market that's close to the breaking point.

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