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Crescenzi: Fed's Balance Sheet Fueling Rally

I've been arguing that in order to facilitate the stabilization of financial firms and shore up the value of financial assets the Federal Reserve would have to expand its balance sheet. The Fed did so with a vengeance this week, according the new date released by Fed late yesterday.

The Fed's H.4.1 release indicates that total Federal Reserve credit expanded by an average of $43.06 billion to $931.34 billion in the week ended Wednesday, an increase on par with the massive liquidity injections posted in September 2001 and for Y2K.

In both cases, the value of financial assets increased very sharply, with U.S. equities posting advances of over 20%. It is hard to imagine an outcome any different than what has transpired, as increases in money supply always lead to increases in asset prices, beginning with financial assets (this is the first and only trade to consider when central bank liquidity increases) and then real assets (this is the second trade, which is some time away, as the economy will take time to recover and boost inflation pressures).

I argued this week that the dollar's value need not fall on the enlargement of the Fed's balance sheet, both because the enlargement is helping to stabilize the U.S. financial system and because market participants are likely to view the enlargement as temporary rather than as a signal of excessive money supply growth that would debase the dollar's value. The rebound that has occurred in the dollar helps validate this view. Nevertheless, if perceptions shift and foreign investors begin to believe that the de-leveraging of the U.S. financial system will require sustained increases in Fed credit, the dollar's value will decline.

For Investors

Now for a pollyannaish view of the secular upturn in the global economy: the bursting of the credit bubble, in combination with the removal of excesses in the commodities and emerging markets has set a foundation for a more stable and lasting secular upturn in the global economy than could have otherwise been possible. Therefore, when the global economy emerges from the current cyclical downturn, it will lifnmgvn10 index gpkely enter a prolonged period of solid economic expansion.

The emerging markets look particularly attractive in this respect. Free market capitalism and economic prosperity will continue to spread throughout the world. This is the secular bet to make. Because of the de-leveraging imperative, the U.S. won't necessarily be part of this picture, at least on a relative basis; de-coupling will return at the first sign the U.S. economic and financial situation has stabilized. This is the kind of thing I am talking about when I stress the value of macro-style investing in my new book, Investing from the Top Down.

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Tony Crescenzi
Tony Crescenzi

Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."

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