Markets have blown through all time highs. Economic activity is running strong. Real Estate is on a seemingly unstoppable growth trajectory. So, how can the party end???
The markets celebrated the eighth anniversary of the bottom of the financial crisis last Thursday, the 9th. For much of those eight years the Federal Reserve was focused on a very aggressive path of loose monetary policy. First with zero bound interest rates, then they ramped up open market activity (quantitative easing). During this expansion, they grew their balance sheet by buying treasuries, which put money into circulation. They extended the balance sheet by nearly $3.6T. Yes, that was a T.
[1] FRB Balance sheet from 9/26/07 to 3/8/17, $869B to $4.4T
It is a foregone conclusion that rates are on the rise; however, the more concerning aspect to monetary tightening is the open market activity over the next few years. As the Federal Reserve Board (FRB) starts selling assets to draw down balances, this removes cash from the system. The free flow of money could be hindered greatly. The party has slowed with the raise of rates, but it could stop as the FRB draws down this massive balance sheet. The balancing act they will have to execute to bring it down and not cause the “R” word is not an envious position. So while most of the focus is on rate hikes, look for open market activity to become the focus later this year.
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[1] www.federalreserve.org – balance sheet trends