Will the Fed Land the One-Two-Three Punch to the Markets?

By Pam Martens and Russ Martens of Wall Street on Parade

Despite President Donald Trump’s leanings toward authoritarianism, he is likely to learn a hard truth this year and next – that the Federal Reserve can make or break his presidency by delivering up to three different gut punches to the markets, which are very likely to spill over into the economy. And without a good economy, even Trump’s most fervent supporters may begin to doubt his omnipotence.

For starters, next Monday the Federal Reserve is scheduled to shrink its purchases of U.S. Treasury securities and Federal agency debt and mortgage-backed securities by another $10 billion a month, from a shrinkage of $30 billion to $40 billion. And by October 1 of this year, the Fed will move from draining $40 billion a month from the markets to draining $50 billion, according to its previously announced schedule. (See chart below.) At the rate of $50 billion a month, that’s $600 billion less in market accommodation from the Fed.

The Fed policy is part of its so-called normalization process to move away from the actions it took to stave off a collapse of the financial system as Wall Street banks cratered in 2008. As a result of its massive bond buying programs known as Quantitative Easing (QE1, QE2 and QE3) the Fed’s balance sheet swelled from $914.8 billion at the end of 2007 to $4.5 trillion in 2014. Its unwinding of its bond-buying program, which began in October 2017, has yet to make much of a dent in reducing its balance sheet, which stood at $4.393 trillion as of its financial report for February 28, 2018.

During his press conference on June 13, the new Fed Chair Jerome Powell mentioned the normalization schedule, stating: “…our program for reducing our balance sheet, which began in October, is proceeding smoothly. Barring a material and unexpected weakening in the outlook, this program will proceed on schedule, and our balance sheet will continue to shrink.”

Powell also mentioned during the press conference how close the U.S. had come to a complete financial meltdown in 2008. He stated:

“…and if I can just take this opportunity to say, you know, the financial system all but failed 10 years ago. We went to work for 10 years to strengthen it—stronger capital, stronger liquidity, stress testing, resolution planning. We want to keep all that stuff. We want to make it, you know, even more effective and certainly more efficient. We want to tailor those regulations for institutions. We want the strongest provisions to apply to the most systemically important institutions. And so we’re committed to preserving and enhancing that structure.”

Unfortunately for Powell, the most systemically important institutions are the big Wall Street banks like JPMorgan Chase, Citigroup, Goldman Sachs, Bank of America and Morgan Stanley who are collectively sitting on hundreds of trillions of dollars in derivatives – a good chunk of which are the credit default swaps that played a major role in bringing down the financial system in 2008. The Fed will announce tomorrow whether it is going to allow these banks (and others) to continue to bleed cash (or take on more debt) through massive stock buybacks and dividend boosts for shareholders. The annual announcement is known as the Comprehensive Capital Analysis and Review (CCAR) and is the second leg of the Fed’s stress testing process for banks

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