So, what recent break-up is more tragic and noteworthy that any romance in Hollywood? It is the break-up of the Federal Reserve with Wall Street.
Quantitative Easing (QE) officially ended last week. No more Fed money printed out of thin air. No more money that helped propel the S&P up over 500% and the Nasdaq over 1,100% from the March 2009 bottom. No more artificial suppression of interest rates that kept the Fed funds rate at zero for 13 years, squashed savings rates for all investors and beckoned them to take more risk in the stock market. Now, as the Fed has officially ended its QE party, Wall Street is lamenting the end of near free money and perhaps recalling the Hall & Oates hit song.
She’s gone, she’s gone. Oh I, oh I
I better learn how to face it. She’s gone, she’s gone
Oh I, oh I. I’d pay the devil to replace her
As you can see in the graph above, since 2009 every time the stock market swooned, the Fed came in with another round of QE to bolster the market. But now that QE has ended, the stock market is going to have to go it alone. Wall Street is single again, on the prowl for another partner. But I don’t think it can ever find a partner as good as the Fed. Frank Sinatra’s ex-wife never remarried. Asked why, she said “Are you kidding? Who’s ever gonna’ replace Frank Sinatra?”
The stock market is now in the same bind.
The Government, through fiscal policy, can flood the economy with money, as it did with the Covid checks and PPP loans. Maybe some of this largess will seep into the stock market. But the Government also needs the Fed to buy the debt it issues from the Treasury to make it all happen. The Government needs the same Fed partner as the stock market, but she’s not available. QE is gone.
She’s gone, she’s gone. Oh I, oh I
I better learn how to face it.
She’s gone, she’s gone.
Oh why, what went wrong?
What went wrong? What went wrong is the onset of inflation. The Fed expanded its Balance Sheet by $8 trillion to facilitate the Treasury in expanding the U.S. government’s debt to $30 trillion. The Money Supply and Deficit both soared with all the QE money created out of thin air by the Federal Reserve. The Fed bought trillions in U.S. government bonds from the Treasury to suppress interest rates and allow money to flow into the economy, which directly benefited the stock market. As you can see below, the increase in the Money Supply (M2) directly aided the stock market.
Flooding the economy with money has other, less positive, consequences too. It makes each successive printed dollar worth less. The more dollars in circulation, the less each dollar is worth. The more dollars in circulation, the less purchasing power the average American has. Everything costs more. With a 10% inflation rate, the dollar becomes worth 90 cents. With a 20% inflation rate, the dollar is worth 80 cents, and so on.
The Fed made a decision- sacrifice QE (and the stock market?) to curtail inflation. So now after the QE break-up, Wall Street has a broken heart. It will never find a partner as good as the Federal Reserve’s QE program.
She’s gone, she’s gone. Oh I, oh I
I better learn how to pray,
She’s go-o-o-o-ne.
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