The Fed Begins to Unwind QE…Finally

The S&P500 barely budged last week, closing on Friday essentially unchanged from the prior week’s close. Volume dropped, and volatility inched downward—but still, the VIX index did not close at or below the levels reached during the summer.

In US macro news, the results were mostly negative. The housing market index fell more than expected. The current account missed. Existing home sales missed. FHFA house prices also missed, and so did PMI composite flash. On the positive side of the ledger, housing starts beat expectations. Leading indicators and the Philly Fed business outlook survey also beat consensus estimates. Once again, there are no indications that the US economic is about to break out with a robust rate of growth. Instead, it’s still stuck at a rate that’s close to (and often under) 2.0%.

Last week’s lack of price movement on the S&P500 means that upward price momentum declined….for both the weekly and daily charts. But the overall patterns remain bullish for both time resolutions. Prices remain well above the 50 day and 200 day moving averages, and both of these averages are comfortably sloping upwards.

One of last week’s biggest announcements in the US financial world was the fact that the Federal Reserve has officially declared a specific timetable for unwinding its massive and almost decade-long Quantitative Easing program. Beginning in October, the Fed will begin to reduce its balance sheet by about $10 billion per month and will increase this amount to about $50 billion per month sometime next year.

Why is this important? Because of all the factors that have driven the S&P500 higher over the last 9 years, none has had a more accurate correlation that the size of the Fed’s balance sheet. And since almost all market analysts accept that the Fed’s QE has driven stock prices (and most other financial asset prices) higher, then it’s perfectly reasonable to assume and predict that when QE goes into reverse, that these prices could suffer. Starting in a few short weeks, we will know for sure.

 

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