“Powell himself alluded to the idea that the Fed may need to restart balance sheet expansion,” he said during an appearance on financial-media site Real Vision. “There’s the potential that we may be re-entering another phase of QE — something which maybe a year ago was laughable.”
The line that Gayed is referencing is from Fed Chair Jerome Powell. At the FOMC’s last policy announcement, he said the Fed may have to “resume organic growth of the balance sheet.” Powell’s exact message behind that sentence is up for interpretation, but what we do know is the Fed won’t hesitate to expand their operations — a practice known as quantitative easing, or QE — in the face of uncertainty.
In fact, it already appears to be happening. After a steady decline, the FOMC has recently added hundreds of billions of dollars to their balance sheet to address liquidity concerns and keep interest rates within their preferred range. And many believe this could just be the beginning.
The graph below depicts a recent increase in the Fed’s assets after an extended period of contraction.
That capital addition is an important distinction — and Gayed thinks that if the Fed continues to inject stimulus into the system, the subsequent action in the bond market won’t be pretty.
“You could very easily see the mother of all corrections in the bond market here,” he said. “I suspect you’re going to have traditional behavior in the bond market take place, which means that every time the Fed has enacted some kind of balance sheet expansion — some kind of QE — the bond market sold off.”
That’s a bit of an anomaly. After all, quantitative easing (QE) is supposed to lower interest rates by adding liquidy to the system.
But Gayed says the opposite is true — and he has the data to back this up.
The chart below depicts the US 10-year’s performance in periods of quantitative easing. Remember, bond price and yield have an inverse relationship, so the spikes higher represent selloffs.
The relationship is undeniable. When QE is enacted, bonds violently selloff.
What’s more, he sees the “tremendous bullishness and complacency” currently baked into the bond market making the nose-dive even worse.
But not all hope is lost — and Gayed thinks certain sectors of the market will benefit from debt’s demise.
“When you look at financials — which would benefit off of yield curve steepening in the US — they’re starting to improve,” he said. “If you look at EUFN — which is the European financials ETF — also starting to look like it’s starting to improve.”
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