The Central Banking Problem: Quantitative Tightening

The stock market has rallied nicely to start 2019 but we think there is a big problem. The major central banks, the Fed, ECB, and BoJ, have pumped up asset prices since 2008 with a massive liquidity injection of $11 trillion. They kept interest rates at ridiculously low levels on the short and long end of the curve and investors were forced into risk assets. This grand experiment is known as quantitative easing. Now is the more difficult part called quantitative tightening, the central bankers are trying to normalize policy.

For the first time, the Fed has started to shrink its balance sheet. It continues to hike rates. The ECB has also stopped its asset purchase program and hopes to hike rates in 2019. Even Kamikaze Kuroda from the BoJ hinted that they are prepared to try and normalize policy. This coordinated monetary tightening has huge negative implications for the stock market over the short term.

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central banks total assets 2

As you can see from the chart above, this is the first time the major central banks have decreased the size of their total assets in a meaningful way.

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central banks total assets vs snp

The correlation between the S&P and the total assets of the major central banks is incredible high since 2008. This should make investors very nervous as the central banks try to shrink their balance sheets. At this time, it is highly unlikely that any of them would step back on the gas to move to QE again over the next year.

Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no ...

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