Fed’s Between a Rock and A Hard-place

While Donald Trump continually attempts to throw his criticisms at Fed. Chairmen J. Powell, investors can’t help but wonder what problems the Federal Reserve really has. In an amazing interview with Druckenmiller on Bloomberg, Druckenmiller points out that Trump’s tweets initially has forced the Fed. Chairman in between a rock and a hard-place. Where the Fed can either A) negate Fed credibility by raising rates while being data dependent, or B) not raising rates, and again diminishing the credibility by appeasing the president.

J. Powell had started his new job during a bull market, hence Jan. 2018 the SVXY was roughly 472.44. Also, the 7 trillion in additional market cap, the Fed had realized it could begin to attempt to unwind its balance sheet due to the acceleration of the economy.

Unwinding the balance sheet means that the Fed will no longer maintain its asset purchasing program, and it will begin to allow the debt to roll off. This, initially, should send interest rates higher and higher. Since rates are rising, investors are expecting a slowdown in equity and an increase in capital inflow to the dollar. Especially since some international central banks are negative. If the United States was capable of unwinding its balance sheet, it would also mean that the rounds of asset buybacks over the last crisis was successful.

However; the unnecessary presidential noise is harmful to the credibility of the fed, but what is worse is with the additional 7 trillion in market cap, the fed has found enough cushion to push itself to insolvency. Not only has the raising of interest rates forced the fed to become insolvent, but it has actually caused an inverted yield curve, and has sent the stock market into bear market territory, with the SVXY now at 50.64, which is a 832% drop from its high.

Since these indicators are flashing red in the equity and credit markets, the federal reserve has decided to pause its balance sheet unwinding.

If you look at the total assets of the Federal Reserve you can see that the Fed has only roughly allowed 12% of its total assets, over the past 3 years, to roll off the balance sheet.

This is tied with the fed hiking itself into insolvency, as well as a 832% drop in the SVXY, which tells us that there is no capable way the Fed can possibly roll off the total 4 trillion dollar balance sheet.

So ignoring all of the noise, and Trump’s outrageous tweets attempting to box Powell into a scenario where he keeps rates low; the Fed has actually put itself in between a rock and a hard place because the capital markets can not maintain higher rates, meaning the recent bullish recovery in the USDX is nothing but hot air.

Since the Fed has decided to no longer unwind its balance sheet, long term interest rates should drop causing an exit from the dollar. With my assumption, we will see this bullish bounce in the DXY regress down towards 85 before any support in its technicals. Until then, it seems that debt investors will have to settle for negative returns on their dollar bonds, or sell their US debt and exacerbate the reversal in the Dollar.