The ‘great unwind’ is here…

From Justin Brill, Editor, Stansberry Digest:

The ‘great unwind’ is here…

After months of speculation, the Federal Reserve formally made the announcement yesterday… It will begin to “taper” its $4.5 trillion balance sheet next month. As the Wall Street Journal reported…

The Federal Reserve indicated Wednesday… it would begin shrinking its portfolio of bonds next month, starting to close the books on an unprecedented and sometimes controversial policy experiment…

Beginning in October, the Fed will end its practice of fully reinvesting the principal payments of maturing into new bonds and instead allow $10 billion in holdings to roll off without reinvestment every month. Those amounts will increase by $10 billion each quarter to a maximum of $50 billion.

The central bank also said it expects to raise rates at least one more time this year. And Fed chair Janet Yellen used the occasion to confirm that the era of “easy money” is ending. More from the Journal

“The basic message here is U.S. economic performance has been good,” Fed Chairwoman Janet Yellen said at a press conference after a two-day policy meeting that ended Wednesday. “The American people should feel the steps we have taken to normalize monetary policy… are well justified given the very substantial progress we’ve seen in the economy… “

Ms. Yellen said there was a “high bar” to resume reinvestments, and the Fed would only do so in the event of a “significant shock that’s a material deterioration to the outlook.” She didn’t outline any circumstance under which the Fed would accelerate the runoff.

As regular Digest readers know, we remain skeptical…

The Fed and other central banks have thrown the monetary “kitchen sink” at the global economy… yet growth remains tepid at best. The inflation they’ve been so desperate to create has yet to show up.

Despite their rhetoric, even the Fed doesn’t know what will happen as it begins to remove this unprecedented stimulus. Maybe they’re right… Maybe the economy will continue to grind higher even without support.

We believe their confidence is misplaced… And we’re apparently not alone. Strategists at Deutsche Bank believe Fed tightening – the beginning of what they’ve called “the great central bank unwind” – could ultimately trigger the next financial crisis. From their recent report titled “The Next Financial Crisis”…

When looking for the next financial crisis, it’s hard to escape from the fact that we’re seemingly in the early stages of the “great unwind” of global monetary stimulus at the same time as global debt remains at all-time highs following an increase over the past decade – at the government level at least – which has been unparalleled in peacetime history…

You slowly become anchored to believe the current situation is normal as it’s persisted for so long now. However, it’s anything but normal. Since the financial crisis, $10 trillion plus has been added to the balance sheets of the four largest central banks with over $14 trillion of assets now owned.

The following chart puts those figures in startling perspective…

But the analysts also note that even this chart doesn’t tell the full story…

If you also add in the record growth in government debt in the U.S., U.K., eurozone, and Japan, you get a total monetary and fiscal stimulus of nearly $34 trillion since the financial crisis. And what do we have to show for it? More from the report…

In the end, $34 trillion of stimulus and [quantitative easing] has delivered only very low growth, subdued inflation, and sky-high asset prices around the globe. This is unprecedented territory and how can anyone estimate what the fallout will be when we normalize again?…

History would suggest there will be substantial consequences of the move especially given the elevated level of many global asset prices… [Even] if the unwind stalls as either central banks get cold feet or if the economy unexpectedly weakens, we will still be left with an unprecedented global situation, and one which makes finance inherently unstable even if we are currently living in the lowest volatility markets on record.

They also worry that if this unwind fails, central banks will be left with little of their usual “ammunition” to stimulate again. Like us, Deutsche Bank fears we could see even more extreme measures next time around…

Could the next recession be the one where policy makers are the most impotent they’ve been for 45 years or will they simply go for even more extreme tactics and resort to full on monetization to pay for a fiscal splurge? It does feel that we’re at a crossroads and the next downturn could be marked by extreme events given the policy cul-de-sac we seem to be nearing the end of.

Again, none of this means a crisis is certain or imminent…

And it’s certainly not a reason to sell all your stocks and move to a bunker. This long bull market has defied critics for years, and it could easily continue to climb the “wall of worry” now. But we’d be foolish not to acknowledge the risks.

For now, we remain cautiously bullish…

Stay long, but continue to watch your trailing stops. And if you’re heavily long the market today, consider “hedging” a bit.

Depending on your circumstances, this might mean shorting a handful of stocks, buying a few long-dated put options (as we’ve detailed in Stansberry’s Big Trade), or simply holding more cash.

You might also be interested in learning more about the options strategies of our colleague Dr. David “Doc” Eifrig…

As we mentioned earlier this week, Doc has just published some brand-new research tailor-made for today’s market environment. In it, Doc explains some simple and easy-to-understand strategies designed to protect your portfolio from a sudden crash or bear market, while simultaneously positioning it for more upside if the bull market continues.

Doc has prepared a short presentation explaining it all… including how you can take advantage of a special, limited-time offer to try these strategies out for yourself. But if you’re interested, we must hear from you by midnight Eastern time tonight. Click here for all the details.

Regards,

Justin Brill

× Subscribe to Crux
Want more posts like these?
Like us on Facebook?
Crux Contributors