The Fed’s balance sheet shrank slightly last week as there was a net paydown of MBS. That will be replaced when the Fed settles its MBS purchases at mid month as it does each month. The Fed has increased its replacement purchases over the past couple of months in order to get the balance sheet back to the unchanged level. Paydowns rose when rates fell earlier in the year and more people refinanced their mortgages. That wave has now ended and paydowns are receding. That will lead to lower Fed replacement purchases in the months ahead, which in turn will mean less support for stock and bond prices.
Bank loans continue to soar as banks lend more, and cash created by the BoJ and ECB flows into the US markets and US banks. The credit bubble continues to grow in spite of Fannie and Freddy continuing to shrink. The banking system is picking up the slack, bringing more risk back to the banks. The assumption is apparently that the loans will be fine because the US economy is growing. That assumption has yet to be tested while the US remains The Last Ponzi Game Standing. With meltdowns under way in Europe and China, capital flight goes straight to the US.
5/24/15 The balance sheet will remain flat until the Fed acquiesces to the fact that it needs to begin shedding assets in order to raise interest rates. That will begin to shrink the balance sheet as it simultaneously sheds assets and reduces bank reserve deposits on the liability side. First it needs to make the decision to embark on that path. That’s coming. As I’ve argued elsewhere, the only way to achieve a rate rise that sticks will be to remove excess cash from the banking system.
If the US markets remain sanguine in the midst of the surrounding maelstrom, the Fed may yet move forward in an attempt to raise interest rates. If US stocks break down, not only will the Fed put that on hold, but it would encourage the Fed to start printing again. It all depends on whether investors continue to buy the con that the US is a safe haven.
