July 10, 2018

Buckle Up For the QT Dump          

As we’ve noted previously, the Fed is currently engaged in an aggressive campaign to shrink its balance sheet.

What started as just $10 billion per month in QT back in October 2016, has since increased to $30 billion in QT per month as of April 2018.

What’s critical to note, however, is that throughout this period, the Fed has largely engaged in its QT drains during the second half of each month.

You may not have noticed it, but the stock market certainly did… with stocks taking a nosedive during the second half of every month in 2018… RIGHT as the Fed began QT.

Take note the red boxes below… the second half of each month has been a bit of a bloodbath. Thank the Fed and QT.


Which brings us to this month… stocks are rising sharply during the first two weeks of trading as usual… just in time for the second half QT bloodbath.

And it will almost certainly be a bloodbath… the Fed’s QT program will increase to $40 billion this month... right as stocks reach one of
their most overbought levels thus far.


Put another way, the Fed will be engaged in its GREATEST liquidity drain thus far... right as investors are fully primed for stocks to roar higher.

And they're ALL going to get taken to the cleaners.

Battle Royale: The White House Vs. the Fed

The Trump White House is currently on a collision course with the US Federal Reserve (the Fed).

First a little background.

The Trump administration has “branded” the stock market as part of its success story. President Trump himself has tweeted on the subject more than 20 times. And Secretary of the Treasury Steve Mnuchin has even stated publicly that the Trump White House views the stock market as a “report card.”

Put simply, the White House wants stocks to be as high as possible.

On the other hand, the Fed has made it clear that it will be focusing on the real economy as opposed to the financial markets. New Fed Chair Jerome Powell has emphasized this approach in multiple speeches and Q&A sessions. He has even explicitly stated that some sectors of the stock market are “overvalued” (an extraordinary statement for a Fed Chair).

With that in mind, the Fed is embarking on an AGGRESSIVE tightening schedule, having already raised interest rates SEVEN times, with an additional five hikes planned in the next 18 months.

At the same time, the Fed is pursuing Quantitative Tightening (QT) in a hope to shrink its mammoth $4.4 trillion balance sheet. QT started at a pace of $10 billion per month. It increases to $30 billion per month in April. And it’s increasing to $50 billion per month this month (July)

ALL of this is VERY stock market negative.

In the short-term, President Trump’s tweets and verbal interventions from cabinet officials can induce a rally in stocks… but it is the Fed that will determine where the markets are heading. It is not coincidence that stocks peaked before QT hit $30 billion per month and have since struggled to reclaim their former highs (despite MULTIPLE efforts by Trump admin officials to “talk up the markets”).


What does this all mean?

The Trump White House and the Fed are on a collision course. And truth be told, unless the Fed reverses course, stocks will drop, and drop HARD.

How hard?

The current downside target is in the 2,300-2,4500 range on the S&P 500.


The time to prepare for this is NOW before the carnage hits.

Ignore the Bounce, the Financial System is in Serious Trouble

The financial system is in trouble.

Indeed, by the look of things, we are about to experience a wave of deflation… in years.

Let’s first talk about the $USD.

The $USD has broken above initial resistance (bottom red line) and currently sits just below 95. This is a MAJOR problem for risk assets.


Now, some of you are no doubt asking “the $USD was at this exact same level in late 2017 and it wasn’t a problem… what’s changed?”

What’s changed is that at that time the Fed was only withdrawing $USD to the tune of $10 billion per month or $120 billion per year. Today it is withdrawing liquidity at a rate of $30 billion per month of $360 per month… and it intends to raise this to $50 billion per month or $600 billion per year within the coming months.

Put simply, the Fed is NOW pulling US dollars out of the financial system at a rapid clip. And it is doing this at a time when the ECB is PUMPING €30 billion into the system per month. Between this and the fact the Fed is on track to raise rates SEVEN times within 24 months (2016-2018)… while the ECB is STILL keeping rates in negative rate territory, the $USD being at 94 is a MAJOR problem for the financial system.

Remember, globally the financial system has over $9 TRILLION in $USD denominated debt. Some $6 trillion of this is in the Emerging Market space. So with each tick higher in the $USD… and with each liquidity drain by the Fed, the system is “drying up” from a $USD perspective.

You can see this in the Emerging Market space where countries like Brazil, Turkey, and South Africa are in literal FREE FALL.


Brazil’s stock market is DOWN 20% YTD. South Africa is down 17% YTD. And Turkey is down 32% YTD. If we were in December (meaning a full 12 months had passed) and the year ended this month, it would be one of the WORST years for Emerging Markets on record. And we’re at those levels only SIX months in.

This issue is now spreading to Asia. China, Singapore, and South Korea’s stock markets have all recently rolled over and are now at their lows for the year.


Put simply, DEFLATION is now rising and it is rising fast. And the Fed is 100% to blame for this. And unless the $USD rolls over SOON, this mess is going to spread into the US markets.

Best Regards.

Deo Talaverano.

Chief Market Strategist DHF.

George Town. Cayman Islands.