Posted by on July 1, 2017 10:35 pm
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Categories: bank Banking Business central bank Economy Equity Markets Excess Reserves federal reserve Federal Reserve Bank Federal Reserve System Financial services Monetary Policy money Negative interest on excess reserves Quantitative Easing US Federal Reserve Wilshire 5000

Authored by Chris Hamilton via Econimica blog,

Just a quick thought about what is driving the US stock market.  The chart below shows the Wilshire 5000 (representing all publicly traded US equities in red), the Federal Reserve balance sheet (black), and excess reserves held at the Federal Reserve Bank by the largest of private(?) banks (likely a majority of these reserves held by foreign banks).  What you may notice is the rise in equities since ’09 correlating with the rise in the Federal Reserves balance sheet until QE ended.  Then a momentary pause in equities during 2015, and another strong leg higher since.  That strong leg higher correlates nicely to the drawdown in the excess reserves held at the FRB, particularly since 2016.

The chart below shows these dynamics since 2008.  The Federal Reserves purchase of $3.6 trillion in new “assets”…and the continual rise in excess reserves banks hold at the Fed until September, 2014.  As the reserves and QE ceased rising and were essentially flat, the market began rolling over.  However, by late 2015 banks began withdrawing those excess reserves and putting them to work…and the equity markets positively responded.

Finally, a close-up of the dynamic since 2013.

But as the Fed is now raising rates, and banks are paid billions in IOER (interest on excess reserves) to do nothing with that money (IOER’s is the Fed’s only means now to raise rates…as explained HERE)…the excess reserves sitting fallow at the FRB have again begun to rise (chart below).

Absent further QE or banks drawing down their trillions in excess reserves…maybe investors should check the color of that swan flying overhead about now?!?  Invest accordingly.

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