Not Worried About the Fed Balance Sheet Unwind

People are worried about the fed having to wind-down their balance sheet: The Fed, a Decade After the Crisis, Is About to Embark on the Great Unwinding

The central bank is likely to announce Wednesday it will start slowly shrinking its $4.2 trillion portfolio of mortgage and Treasury bonds purchased during and after the financial crisis. It will do so passively by allowing some bonds to mature without replacing them.


The markets haven’t blinked at Fed signals for many months that this moment was nearing. But plenty could still go wrong. The central bank has never before had such a large balance sheet or attempted to do this.


If it succeeds, the central bank will quietly close a chapter on an extraordinary policy experiment that lowered borrowing costs for homeowners, businesses and consumers, and will provide a model for other central banks that followed suit. A misstep could disrupt growth at a time when major economies are finally expanding in sync.

Since 2008, given all the failed past predictions, such as predictions of a relapse of 2008, predictions that rising interest rates would hurt the US economy, predictions of hyperinflation & dollar collapse, and predictions about how the fed ending QE would hurt the economy, I have every reason to believe, even without knowing all the details of this story or having any claim to clairvoyance, that this too is nothing to worry about and will pass uneventfully like everything else. One of the nice things about empiricism is I can trust the data before my eyes instead of having to perform mental gymnastics to try to rationalize it away. Against all odds, policy makers keep pulling through, defying predictions of doom. It doesn’t always make sense, but sometimes you have to suspend skepticism and put your faith in IQ and policy. It’s one of the great paradoxes/contradictions: if society seems so dysfunctional and politicians are so inept, why hasn’t everything fallen apart?

The efficient market hypothesis also stipulates that this is wind-down is already priced into the bond and stock markets, so betting against the bond market in anticipation of these bonds flooding the market and thus depressing prices, is far from a sure-fire strategy.

There is no compelling evidence that market timing works, especially in terms of technical analysis but also fundamental analysis. In 2015-2016, there was talk about a so-called ‘earnings recession‘, but had you sold, you would have missed out on the 15% rally that followed. Had you sold in 2011 during the European debt crisis, you would have missed out on 130% subsequent gains. For years, people have been attributing the rally to the fed and such, ignoring the fact that the fed ended QE in 2014 and yet the market has risen 25% since then. Purported successes of timing (such as moving averages, recession indicators, crossovers, etc.) are due to statistical and data mining biases, that cannot be replicated with similar success.

If I had to guess, the market is going a lot a lot higher even if valuations seem kinda high. Inflation and interest rates are still historically very low, which makes stocks attractive to bonds and cash, and profits and earnings are also strong.

The economy and market cares only about two things: earnings and innovation. Until those change, I see no reason for the market to fall a lot (and as explained above, timing strategies don’t work due to generating too many false positives…either you’re ‘in’ or you’re ‘out’). It’s sorta like the concept of Gnon concept of NRx…it (the market) is deaf to your own judgments about how the economy and stock market should be; it operates on its own accord. Gnon, in the deterministic sense, is the underlying current that brings society to its inevitable destination.