Conducting Bernanke's Symphony No. 3 In F Major

Includes: SPY
by: Eric Parnell, CFA

The Fed's QE3 stimulus program has taken on a clearly distinct rhythm. Thus far, the liquidity injections into the financial system have come on a selected few strong notes that have occurred roughly every four weeks. And following this 4/4 meter of the Fed's newest monetary policy symphony, the next major injection is set to burst into the market starting next week.

Since the launch of QE3 back in mid September, the Fed's balance sheet has been trending higher. But it has been doing so with much vibrato.

(click images to enlarge)

This variation in the movement of the Fed's balance sheet can be explained by composition of the assets being purchased as part of the program. QE3, at least to this point, is exclusively focused on the purchase of mortgage-backed securities (MBS) at a rate of $40 billion per month. And although the Fed commenced the purchase of MBS immediately following their September 13 policy announcement, the settlement of these purchases is often delayed by several weeks to a few months. For example, while the Fed committed to purchase a block of mortgage-backed securities totaling $950 million on September 14 -- which was the first day that QE3 was put into action -- this trade is not scheduled to settle until next week. Thus, it will have taken a full three months for the MBS to be exchanged for cash in this instance.

Overall, these settlements occur on a few specific dates each month, which helps explain the rhythmic pattern of the Fed's balance sheet expansion thus far. The last major MBS settlement block occurred on November 14, for 30-Year Term Fannie Mae and Freddie Mac securities and was followed by two smaller MBS settlement blocks on November 19, for 15-Year Term Fannie Mae and Freddie Mac securities and November 20, for 30-Year Term Ginnie Mae securities. This helps explain the big liquidity burst during the week at the front of the latest meter followed by a second smaller increase the following week.

Looking ahead, the next major rush of Fed liquidity from MBS purchases is set to arrive starting next week. The three major settlement dates for December are December 12 for 30-Year MBS, December 18 for 15-Year MBS and December 20 for 30-Year GNMA. The asset totals for these upcoming settlements are already confirmed to be at least $44.25 billion, $12.65 billion and $13.95 billion, respectively, and could reasonably come in around $54 billion, $16 billion and $17 billion, respectively, if not more once the final operational results are revealed by the Federal Reserve Bank of New York on December 13. This suggests that the amplitude of the MBS purchases at the beginning of each 4/4 meter is only set to increase with each passing month, as the preliminary estimates for December totaling $87 billion are more than 50% higher than November's totals.

What implications if any does this have for stocks? If recent history is any guide, it may have an increasingly notable impact. When the Fed's first QE3 injection found its way into markets in mid-October, the stock market as measured by the S&P 500 (NYSEARCA:SPY) increased by +3%. And when the second larger round of liquidity flowed into the system in mid-November, stocks advanced a more pronounced +6% and managed to break back above critical resistance at the 200-day moving average in the process.

So what might we expected from stocks with the next wave of liquidity set to arrive next week? Clearly, these forces will be placing meaningful upward pressure on stock prices. Thus, an even more robust advance is possible over the coming weeks, but such an outcome will depend on the various other macroeconomic, political and market forces also at work in the markets along the way. Most significantly, events surrounding the fiscal cliff, including even reaching a compromise resolution, could send stocks on wild and unpredictable swings at any moment in time. But all else being equal, these monetary stimulus-induced forces are likely to provide a steady tailwind for stocks as we move through the next two weeks.

The Fed's latest symphony is likely to remain in its current 4/4 meter as the first movement plays out through the end of the year. But as we move into 2013, do not be surprised if the second movement of the Fed's score takes on a notably quicker tempo. For once outright U.S. Treasury purchases are added to the composition as expected, the Fed may be striking a particularly strong note on the liquidity injection front each and every week. And while this may help send stocks euphorically floating higher over the coming months, the key of the Fed' symphony in F Major hints at what may befall the U.S. economy and its markets once the music of Bernanke's latest opus finally comes to an end over the next 12 to 18 months. And this final end game outcome will be particularly worth listening to once it finally arrives.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.