The Most Important Chart For You To See Right Now…
There was a lot of news last week.
We saw headlines about impeachment… the trade war… Brexit… Syria… and Saudi Arabia. All important stories.
But there was another story that broke late on Friday and wasn’t widely covered… and that story may turn out to be the most important of the bunch.
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According to the announcement, the Fed plans to buy Treasury bills at an “initial” pace of about $60 billion from mid-October to mid-November. They will then adjust both the timing and amounts of bill purchases “as necessary to maintain an ample supply of reserve balances over time.” The buying will continue at least into the second quarter of 2020.
New purchase amounts will be announced on the ninth business day of each month.
The Fed will continue to intervene in the repo market, a crisis that emerged last month. The Fed will keep those operations going “at least through January.”
What’s interesting is that the Federal Reserve sent several officials out to stress that this new plan was not another round of quantitative easing (QE). Fed Chairman Jerome Powell was uncharacteristically clear. Powell usually makes statements that leave listeners confused as he winds through several points, sometimes contradicting previous assumptions. But this time around, he seemed to know what analysts would think. So, to make sure there was no room for interpretation, he went with the rare short sentence.
“This is not QE.”
As one analyst noted in The New York Times article, “When it swims like a duck and quacks like a duck, it’s hard to prove your intentions aren’t fowl.”
And the Fed’s plan certainly seems to swim and quack like QE.
These moves caught analysts by surprise. The size of the purchases is large. In the last round of actual QE that ended in 2012, the Fed was buying $85 billion of bonds a month.
QE is designed to stimulate the economy. The Fed’s insisting this isn’t QE because they don’t want to create the impression that the economy is weak. Thus, this program to stabilize reserves rather than QE.
The Most Important Chart In The Entire Market
This news made me think of a research report I saw last week in MarketWatch. That report noted:
Bank of America Merrill Lynch highlighted a particularly turbulent period of American history between 1968 and 1976, which included the Vietnam War, the end of the Bretton Woods monetary system, an oil crisis and U.S. President Richard Nixon’s near-impeachment.
Despite all of the above, BAML said the Dow “slavishly followed the path of Fed policy — easing caused rallies and tightening caused corrections.
This chart is a work of art. In fact, it may be the most important chart for you to understand where the market is at right now. The scaling allows it to convey an effective message.
The black line shows the Dow Jones Industrial Average. The gold line is the fed funds rate, a key interest rate controlled by the Fed. The yield is inverted so that low values are higher on the chart and higher values are lower on the chart. This means interest rates are moving down as the gold line rises and vice versa.
In the chart, the relationship between the Fed and the stock market is clear. As the Fed cuts, stocks generally rise. As the Fed tightens, stocks generally fall.
News may have created short-term moves in the 1970s, but the Fed drove the long-term trend.
Why This Matters
In the past two recessions, the Fed cut rates by 5%. But when the financial crisis took hold in 2008, short-term rates were already lower than 2%. The Fed couldn’t rely on interest rates; they needed new tools. And that led to QE.
The Fed’s latest plan relies on the same tools they used to implement QE in the early 2010s. The only difference is that, this time, they’re saying that they don’t plan for their purchases to stimulate the economy. But no matter what the Fed says, the results will likely be the same. Their purchases are adding money to economy, and those dollars need to go somewhere. They are likely to flow into stocks.
For the S&P 500, the Fed’s action provides a price target of about 3,300. That target is determined by the chart below.
The blue rectangle highlights recent market action. One way to interpret this pattern is that traders are waiting for news that indicates whether they should buy or sell. The trading range forms as they await news. The Fed provided the news that should push prices out of that range.
The price pattern projects a 300-point gain when prices move above the upper bound of the recent trading range. This is a move of about 10%. Prices won’t move straight up but, for now, the trend seems to be positive.
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