In a prior post, we opined that the Fed’s 1/4% rate increase shouldn’t have a material effect on business investment or consumer mortgage rates.
For details, see Fed Watch: Is 1/4 of 1 percent a big number or a little number ?
But it will have a BIG impact on the cost to service the U.S. Debt … which is now over $18 trillion.
A basic math principle: A little number times a very big number results in another very big number.
In this specific case, $18 trillion times .25% equals $45 billion.
That said, I don’t think that the Fed discount rate is the right number to watch … especially if you’re a stock market watcher.
An indicator that I like to track is the Federal Reserve Balance Sheet — the accumulated value of bonds & notes that the Fed buys by printing money (blue line below
Simply stated, the more the Fed buy, the bigger the money supply.
Conventional wisdom: the bigger the money supply, the more fuel the economy has for growth.
That’s true, except when businesses and consumers decide to stash the cash rather than spending it … which both are doing … as evidenced by a sliding ‘velocity’ of money.
So, where does the extra money go?
Yep, the stock market … which despite low returns, is still the best game in town.
The increased money supply ends up boosting stock prices … which is fine as long as the money supply continues to expand.
But, what happens when the Fed stops printing money to buy bonds & notes?
Simple, stock price gains are halted … or reversed.
Now, take another glance at the chart showing the amount of assets on the Fed’s balance sheet (blue line) and the S&P 500 (red line).
First, note how closely the lines track …. pretty high correlation.
Second, note how the blue line has flattened since mid-2014 … indicating that the Fed has slowed the expansion of the money supply.
Finally, ask yourself: “What’s likely to happen to the stock market?”
Happy New Year, everybody ….