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Right now, everyone wants to know how much more the Fed's going to hike, what the terminal rate will be (the highest level that fed funds get to), and how long might they keep rates elevated.
But that's looking in the wrong direction. We know the answers already.
Rate hikes aren't as important as they've been simply because the Fed's done frontloading and future hikes will be smaller in magnitude, and markets know that. The terminal rate will probably be 5%, because that's what the Fed just said they want it to be, so that's already baked in. We also know they're committed to keeping rates up until inflation gets to around the 2% annual goal the Fed has set in stone, for now at least.
The real damage you need to get ready for is from quantitative tightening (QT), the reduction of the Fed's $8.6 trillion balance sheet. They're letting billions of dollars in maturing assets "runoff" the balance sheet, meaning that they won't be replaced.
Problem is, someone's going to have to buy them. And unlike in prior years, when the world lined up to buy Treasury bills, notes, bonds, and mortgage-backed securities (MBS) from the U.S. government, there aren't going to be any takers this time.
That's why QT is going to be the straw that breaks the camel's back, for both bonds and stocks.
Let me show you what's been happening, what the damage is going to look like, and the very best way you can set yourself up to come out ahead as things shake out.
Why QT Is Such a Poison Pill for Markets Next Year
QT, for now, isn't about the Fed actually selling Treasury bills, notes, bonds, or agency MBS out of their balance sheet. It's about allowing maturing assets to "runoff" the balance sheet, like I said.
All runoff means is that as assets mature and come out of the Fed's balance sheet they won't be replaced. So, no more Treasury or MBS buying by the Fed. No more "buyer of first resort" anymore.
Starting in June through August this year, the Fed let $30 billion in Treasuries and $17.5 billion in MBS, per month, runoff their balance sheet. In September they raised the "cap," how much they assigned per month to let runoff, to $60 billion a month for Treasuries and $35 billion a month for MBS.
Now here's the problem.
That's $95 billion a month worth of Treasuries and MBS that other buyers are going to have to step up and buy. Not because the Fed's selling them and looking for buyers - they're not selling anything yet, they're simply letting them mature.
But the U.S. Treasury must still issue new debt as well as rollover all its maturing debt, including all the Fed's runoff debt, because they don't have the principal to pay off all that maturing debt. They don't have the principal to pay off any maturing debt for that…
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.