zerohedge November 30, 2018

Authored by Eric Cinnamond,

In a recent post I noted, “…barring a consequential decline in asset prices, I believe the Federal Reserve will be forced to continue increasing rates and unwinding their bloated balance sheet.”

While I did not have a number in mind when I used the word “consequential”, I certainly didn’t believe a flat YTD number on the S&P 500 would cause the Fed to alter their plans.

And that, of course, is what markets were led to believe yesterday after Jerome Powell stated the funds rate is “just below” the Fed’s theoretical neutral rate.

Now that we have a better understanding of the Federal Reserve’s tolerance for financial instability (not much), I believe investors are in a better position to gauge future policy responses related to further declines in equity prices.

I put my best guess together in the Federal Reserve Cheat Sheet below:

S&P 500 YTD          Policy Response
5%+                    Gradually raise rates
+5% to -5%          Hint at a pause
-5% to -15%         Pause
-15% to -20%       Hint at rate cut/ending QT
-20% to -25%       Cut rates and end QT
-25% to -30%       Hint at QE4
-30% or worse      Implement QE4

Source: Conversation with myself on the way home from grocery store, Margin of error: +/- a lot

So there you have it. Of course this is just a wild guess from an unqualified guesser of monetary policy. And I’ve certainly been wrong in the past. In fact, before this week, I thought Chairman Powell might be different. Not Paul Volcker different, but possibly less willing to backstop the financial markets relative to Greenspan, Bernanke, and Yellen.

However, after his speech this week, I’m now leaning towards more of the same. And I suppose I can’t blame him. Powell inherited a tremendous amount of asset inflation.

Similar to a banker with a large book of loans, no one wants to see the loans go bad on their watch (especially if they weren’t the underwriter).