Maybe, the Fed’s 1/4% rate increase is just a shiny object …

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.

 

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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.

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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

image

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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.

image

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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.

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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).

image

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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 ….

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