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Think again about your trading strategies. The following chart is a shocker. It comes from the FRED data base of the Federal Reserve Bank of St. Louis. Take a look –

click to enlarge

The chart compares the S&P 500 Index since January 2009 to the Federal Reserve Bank Credit. In Fed-speak, the Reserve Bank Credit is the total money the Federal Reserve loaned banks, plus US government debt the Fed bought, plus other credits the Fed gave troubled banks. In plain English, it’s the money printed by the Fed in its “quantitative easing” programs QE1 and QE2. The Fed injected new money – printed money - into the economy by buying government debt and making loans to banks.

The shocker is the correlation between Federal Reserve money printing and the S&P 500 Index. The S&P rose when the Fed printed money. It stopped rising when the Fed stopped printing. This may now be a major factor in our trading strategies.

QE2 ended on June 30, what will happen to the market now? The market may begin to sink, if the pattern of the past two years holds. It has long been said that “liquidity drives the markets,” i.e., prices will rise to absorb the available cash. Much of the liquidity provided by the Fed was absorbed in the de facto inflation of stock prices. Some skeptics say this makes a QE3 inevitable.

How long can the Fed continue to bail out the stock market without risking broad inflation? The government is under pressure to revive the economy, but it’s caught in a dilemma. End quantitative easing, and the result may be rising interest, falling stock prices, falling bond prices, and unemployment. Continue quantitative easing, and the result may be inflation, or even hyper-inflation.

We can only wait to see what the Fed does, and its effect on the economy and on our trading strategies. But watch the Federal Reserve Bank Credit closely. It may be a new leading indicator, allowing us to forecast stock and bond prices.

Source: Federal Reserve Bank Credit May Be a New Leading Indicator