We had a ritual at Lehman Brothers…
Around 8:30 a.m., on days when we were awaiting news from the Federal Reserve, we would all stop what we were doing.
We would gather in front of a big TV screen on the trading floor… and watch for the Fed’s next move.
This was in the early 1990s, before 24/7 news streaming.
We waited for news of what Alan Greenspan (then chairman of the Fed) would do with interest rates and other monetary policies. Then, we’d race back to our seats and trade.
I was a senior strategist at Lehman back then. But three decades later, not much has changed.
The market still hangs on to the Fed’s every word. It’s a big reason for the chop we’re seeing in all asset classes right now.
That’s because the market hates uncertainty. And the Fed gave us plenty of that as we closed out 2021 and kicked off 2022.
It stoked uncertainty over its ultra-cheap interest rate policy. It also said it would curtail the size of its mega-book of assets. But even though the Fed is talking hawkish, I don’t expect it to follow through.
I’ve said it many times before: The markets are the Fed’s third and unofficial mandate. And as I’ll show you today, that presents an opportunity for you.
It Wouldn’t Be the First Time the Fed Walked Back Its Hawkish Talk
We’ve been there, done this with the Fed before.
In 2015, the Fed said it would hike rates three to four times. But the markets said no, and the Fed walked back its hawkish talk.
In the end, it waited until December 2016 to raise rates – and it raised them by only 25-basis points (or 0.25%).
The reasons for rate hikes are slightly different now than in 2015. Yet at the end of the day, the Fed is a market watcher and rescuer, and it acts accordingly.
Remember, the markets are the Fed’s third and unofficial mandate, next to price stability and full employment.
And that’s not because more than half of all Americans have some sort of investment in the stock market. It’s also not because of how the stock market affects the rest of the economy.
The real reason is much more self-serving than that. And it goes way back to the Fed’s early days.
The Fed’s Hidden Third Mandate
The Fed claims to care about the economy above all. It operates under a dual mandate that became law in 1977.
That law says the Fed must balance price stability (meaning control inflation)… and full employment (its metric of economic strength).
But in reality, the Fed cares most about its shareholders – the big banks.
The big banks care about their mega-customers, the big corporations. And the big banks and big corporations both care about liquidity – and their share prices rising.
It’s just the chain of things. And this is nothing new…
It started with the Federal Reserve Act of 1913. That act established the Federal Reserve System (aka the Fed).
The promise, or lie, was that the Fed would put an end to boom and bust cycles. Clearly, it didn’t. Instead, it became the money well for Wall Street.
See, 12 different reserve banks make up the Fed. These banks are strewn across districts throughout the country…
And they’re the ones who own the Fed. That’s because the Fed is a quasi-corporation, members-only club. It’s not a government institution.
Sure, the President chooses the Fed’s board of governors, and Congress confirms it. But the government doesn’t own stock in the 12 reserve banks. Member banks – such as JPMorgan Chase, Citigroup, and Bank of America – do.
For decades, I’ve covered how the Fed coddles Wall Street… as well as its collusion with other central banks worldwide. I even visited the remote place where it all started – the Jekyll Island Club off the coast of Georgia.
A group of six elite men – including influential bankers and a wealthy Senator – crafted the idea for the Fed at a meeting there in 1910. I visited the Club in 2014 to get the scoop and made a short video about it. (You can watch it below if you’re interested.)
In short, each member bank has to own an amount of stock worth 6% of its capital. They pay half of that money to the Fed. Where the rest goes is a mystery.
There used to be a report showing how much stock each bank owned. But during my research for my 2014 book, All the Presidents’ Bankers, the last one I found dated back to 1941.
Suffice to say, the bigger banks own a greater percentage of the Fed than the smaller ones do.
The Fed’s Catch-22: Trying to Serve Two Masters
This brings us back to today, and the chop we’re seeing across all asset classes. Markets made it clear how unhappy they were. That’s why volatility spiked last month.
The S&P 500, Dow, and Nasdaq all dipped into what’s called “correction territory” during January. That’s when stock markets or individual stocks shed 10% or more of their value.
But they rebounded on the two last trading days of the month to exit that correction. Still, the Nasdaq fared the worst, losing 10% in January.
The media also fanned the flames of the market’s fear. For example, The Wall Street Journal said, “The Federal Reserve is about to end America’s era of easy money.”
But that couldn’t be further from the truth.
Even if the Fed does what it indicated it would… and it raises rates by a full 2% over two years… that does not mean an end to easy money.
The Fed is in a Catch-22. It’s trying to serve two masters – the markets and the economy.
At the end of the day, the financial system is more afraid of losing its cheap-money fix than of inflation or a virus.
I don’t believe the Fed is going to raise rates six or seven times this year…
Even though that’s what Jamie Dimon – the CEO of my former employer, JPMorgan Chase – predicted. I believe it’ll be three, tops.
Still, when there’s uncertainty over something as addictive as cheap money… the markets tend to overreact.
The Fed is watching this, as it did in 2016. Other major central banks will hold their dovish stance, as they did then, to keep a balance of calm.
What This Means for Your Money
Now, as I said on Thursday, when the markets are choppy, the best thing is to step back and consider the full picture.
To that end, take a look at the chart below. It shows the Fed’s balance sheet since 2008.
The blue line shows how much money the Fed added to its balance sheet since the pandemic started. The dashed lines show what it would have to do to bring it back to where it was before the pandemic.
You can see that the Fed would have to do a lot of selling to get its $9 trillion book down to its pre-pandemic size.
But as I said, there’s very little chance the Fed will follow through on that. And here’s where the Fed’s “third mandate” represents an opportunity for you.
Since the Fed cares about markets, it will not raise rates by too much or too quickly if the markets react badly.
What that means is that… if the markets freak out when the Fed makes its initial rate hike… the Fed is likely to reconsider the pace or magnitude of future cuts. (That rate hike will still cause another volatility spasm – but we’ll be with you when that happens.)
And today’s opportunity is in the bond markets…
My analyst Eoin Treacy wrote about the yield curve spread last month.
In a nutshell, the yield curve spread tells us how expensive liquidity is. It measures the difference in yield between two Treasury bonds.
The yield curve has been flattening, as expectations of rate hikes caused short-term rates to rise relative to longer-term ones.
But I don’t think the Fed will hike rates by as much or as fast as it has indicated. If the Fed does not hike rates by as much as it has signaled, the yield curve will steepen.
The best way to take advantage of this is by buying the spread between 5- and 10-year Treasury yields.
To do this, you can buy the Vanguard Intermediate-Term Treasury ETF (VGIT) and the ProShares Short 7-10 Year Treasury (TBX) in equal amounts.
Happy investing, and I’ll be in touch again soon.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
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