A neutral Fed is fuelling equities, but the tide is going out.

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A Patient Fed on the cost of money.

The US Fed has declared that it will be “patient” in deciding whether to continue raising interest rates.

This is the single biggest reason for the recent rally in US equities (and works in an opposite way to rising interest rates which can be a stake in the heart for equities).

Brexit, China, trade wars and other facets are not the key drivers.

Recently, the Fed pacified markets (and Donald Trump) by winding back its expectations for the number of rate hikes this year, and reiterating its ‘patient’ view.

Equities flew higher.

But the Balance Sheet run-off is about draining liquidity.

Off in the wings, however, sits the balance sheet run-off that started in 2017 and continues to run with no change in pace or quantum since it started.

This means that whilst the Fed has signalled a halt in rate hikes, it continues to drain the economy of liquidity. This is about supply of money, not cost.

One way to view the liquidity run-off is through the lens of the US Monetary Base. It currently sits around 19% below its $4.2 trillion peak on 15 April 2015 - when interest rates were in a range of 0%-0.5%.

The Loch Ness of free and easy money.

Think of April 2015 as the Loch Ness of free and easy money, represented by the top of the red line below.

NextLevelCorporate extrapolation from St. Louis Fed data.

NextLevelCorporate extrapolation from St. Louis Fed data.

Since April 2015, around 1/5th of financial liquidity has been drained from the Loch (mostly post September 2017) and the cost of the remaining volume has increased by around 900% (albeit, off a low base).

Whilst ‘cost’ is continually discussed in the press, volume remains a silent and blunt instrument that will surely be grappled with soon.

Mike Ganon.


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