Opinion: When Will We Stop Caring About The Fed? After Tapering.
A brief explanation of how we got ourselves into this weird game of being at the Fed's beck and call, and our thoughts on the market after the Fed has tapered.
We’ll Stop Caring Once They’ve Tapered
We’re not going to talk about when we think they’ll taper yet. That’s a big point of contention in the investing community right now. Additionally, it’s not likely to have that big of an impact on the market, or any of our portfolios.
The point is that tapering, and all the hyper surrounding it, will be mark a larger shift to more normal market conditions. Yes, we know “normal” is a loaded word. We’ll explain “tapering” and what we mean in this piece.
Why we cared in the first place
The main thing controlling the market at any time is investors’ risk appetite.
This was dictated by how much cheap money big investors could borrow from the Fed during the pandemic. The Fed made money very cheap, but controlled the cost of that money (or how “cheap” it was/is). At the same time, we were in a pandemic, and this policy of cheap money (i.e. Quantitative Easing (QE)), wasn’t obviously going away soon. Consequently, big money felt confident/good about investing so as long as people were suffering, because the Fed would need to continue their cheap money policy.
Slowly, less people suffered. More people could work as Covid restrictions were lifted. This meant the Fed had to begin thinking about slowing down the money-printer, or making money less easy to borrow, thereby coaxing investors to begin paying attention to the Fed for signals on when they should stop borrowing money and inflating the stock market.
More detailed explanation: The pandemic allowed for cheap loans or bonds (overnight funds) for banks, who all knew to throw it in the stock market
Here’s the more detailed explanation.
During the pandemic, investors’ risk appetite grew as the Fed lowered interest rates on (i.e. the price of) overnight funds — thereby “cheap” or money if it’s invested — to virtually zero. By “cheap” money, we mean very low interest rates on overnight funds.
Overnight funds are bonds/loans issued to banks that need to be return “overnight” the next day, or in a very short time period. Banks would use overnight funds as a practically free loan, then throw that money in the stock market, make like 5% in a day, then give their money back. Since we’re in the Information Age, they can borrow a kajillion of these per day, and make super income as long as the market is going up. Since everyone was getting free money and throwing it in the stock market, it went up, and everyone made money.
Dependent on how much cheap money they could get/borrow from the Fed, banks would borrow, invest, and loan out their money to institutional investors who would invest even more. Money was cheap, so they could borrow a lot. This pumped the stock market to the highs we just saw.
All this cheap money was being given to them as a part of the Fed’s QE policy, which is in place to help the U.S. economy recover from the pandemic.
But since we’re recovering, the Fed is thinking about making the money more expensive or giving banks less money by buying less bonds and lowering interest rates on those bonds. This is known as tapering.
Tapering
“Tapering” Means Slowing Money Injections, or More Expensive Money For Banks
As a reminder, “tapering”, in today’s context of the Federal Reserve System (aka. the Fed) and finance refers to the Fed’s slowing of purchases of Treasury bonds and Mortgage-back securities. It can also refers to raising interest rates on overnight funds.
These bonds were (and still are) at extremely low interest rates in order to inject money into banks and the economy. Now, we’re despite all the news about stagflation and weird GDP growth, we’re lookin’ much better than before. Ergo, we don’t need as much cheap money.
“Tapering refers to policies that modify traditional central bank activities. Tapering efforts are primarily aimed at interest rates and at controlling investor perceptions of the future direction of interest rates. Tapering efforts may include changing the discount rate or reserve requirements.”
The main reason we’re concerned about the Fed is regarding how they handle inflation and how much money they give banks. Tapering effects both of these things.
Leaving the “All Eyes On Powell” Phase
For the past two years, all eyes have been on the Fed. Whether it's helping manage the end of the presidency or literally handing out money to people, we've paid attention.
But we're slowly exiting that phase. Biden will reach a year in office soon, Covid issues are now vaccination issues, that are slowly getting under control as much as we’re learning to live with Covid. To cap it all off, now everyone’s talking about tapering.
But what happens after we’ve tapered?
What will move the market like Powell did?
Right now, it’s too hard to say and we haven’t thought about it hard enough.
If Powell actually tapers before the middle of next year, our best guess is the following:
Congressional elections - Democrats very narrowly have the majority in the house and the senate, but this could change, and with it policy
Tech-focused legislation - the pandemic solidified what we call “tech” as key infrastructure to our society, so once they have time to focus on
Maybe Bitcoin’s price - this might be seen as a reflection of investor sentiment toward inflation, kind of like the 10Y Treasury yield
The usual sector rotations - investors rotate money in and out of different kinds of stocks
These would likely take effect later next year once people have stopped worrying about the effects of tapering and inflation.
It’s really difficult to say any of this with conviction though. Elections at the federal level are always a market-mover, pandemic or not, and the same goes with legislation. These are just the most immediate things we’d face… we think.
The pandemic has changed our financial and social environment
After a crash or correction, it’s reasonable to think about prior forces that drove the market. Before, it was the usual: legislation, natural disasters, and foreign relations. These will always move our markets.
But everything that might effect how companies are fundamentally valued — which is, in theory, what stock prices are supposed to reflect, has practically changed. Everything from …
prices (i.e. inflation dynamics),
employment and hiring, and
consumer behavior, to
the way we view the stock market as a whole
… has changed. People have jobs to sell or do things, people buy these things at prices, and make companies money which they make decisions about. Everything in that equation has changed drastically.
Who ever would have thought that “meme stocks” would ever be a thing? Not us. But it’s inspiring to know that retail investors can actually move stock prices to an extent.
We’ve had more confirmation than ever about how rigged the stock market can be. It’s difficult to say that it’s intentionally rigged against retail, or non-institutional investors, but it definitely isn’t set up for us.
We’ll keep you in the loop with our thoughts on this, and will likely follow up in the coming weeks.