Yesterday I outlined why I believe stocks are due for a significant correction.

By quick way of review:

1. Stocks recently broke out to the upside of a consolidation period, but have yet to confirm the move.

2. “Underneath the hood,” market internals are extremely overstretched, suggesting a retracement/correction is coming.

The question is, what precisely would trigger this correction?

Yesterday I outlined the most likely reasons we’d see a significant market drop. They are:

1. The economy rolls over.

2. Inflation begins to eat into profit margins, lowering corporate profits.

3. Inflation expectations soar suggesting the Fed will be forced to taper/end its interventions and tighten monetary policy.

4. A true black swan even no one sees coming (another COVID-19 variant? War? A major funding issue with a foreign bank?)

Of the above scenarios, the most likely is number 3: Inflation expectations soar suggesting the Fed will be forced to taper/end its interventions and tighten monetary policy.

The Fed Comes to the Rescue (Again!)

As you are no doubt aware, one of the biggest drivers for the stock market since the COVID-19 lows of March 23, 2020 has been the Federal Reserve’s monetary policy.

We’ve covered this topic before, but it’s worth repeating.

On Sunday March 22, 2020, staged an emergency meeting in which it announced it would:

1. Make its QE program “unlimited” meaning it would simply print money and buy assets ad infinitum.

2. Increase the scope of its QE program from simply buying U.S. Treasuries and mortgage-backed securities to include:
1. Corporate debt or debt issued by corporations.
2. Corporate debt-related ETFs (stock funds linked to corporate debt).
3. Municipal debt (debt issued by states, counties, and cities).

3. Expand its money market QE to also include a “wider range of securities” including Certificates of Deposits (CDs).

4. Expand its commercial paper QE program.

5. Introduce a new QE program to buy any asset backed security (ABS) including student loan debt.

6. Begin a bailout program for small- and medium-sized businesses.

7. Lower the interest rate on its repo programs from 0.15% to LITERAL ZERO (meaning NO interest charged).

All told, the Fed’s various programs involved printing over $3 trillion in the span of four months (March 2020 through the end of June 2020). It has since printed another $600-$700 billion.

These policies led to stocks hitting new all-time highs within six months of the COVID-19 meltdown. They also greatly exacerbated wealth inequality in the U.S. And this, in turn, has made the Fed’s policies politically toxic to a degree (hence why the Fed is not virtue signaling about diversity, climate change and other social justice issues).

But Now the Free Money Party Has to End

However, with inflation now raging, the Fed is running out of room to maneuver. Fed officials have been posturing that inflation is “transitory” to buy themselves time, but the reality is that on some level the Fed is fully aware this is a lie…

Indeed, we’ve now had four separate Fed officials suggesting the Fed should consider tapering its QE program or tightening monetary policy in some format. They are:

• Philadelphia Fed President Patrick Harker
• Dallas Fed President Robert Kaplan
• Cleveland Fed President Loretta Mester
• Fed Vice-Chair Randal Quarles

Moreover, the April FOMC minutes, released in mid-May suggest a “number” of Fed officials are ready to consider making changes to its monetary policy. Some highlights from that release are below (emphasis added):

A number of participants suggested that if the economy continued to make rapid progress toward the Committee's goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.

…a couple of participants commented on the risks of inflation pressures building up to unwelcome levels before they become sufficiently evident to induce a policy reaction.
Source: Federal Reserve

April CPI was clocking in at 4.2% when the Fed was saying this.

All of this suggests the Fed will be tapering sooner rather than later. With stocks depending so heavily on the Fed’s interventions, this opens the door to a significant correction.

Indeed, we now know the Fed is 100% aware inflation is a real problem for the economy based on the Fed’s latest Beige Book. So, for the Fed to claim ignorance is no longer a valid excuse.

I’ll explain why in tomorrow’s article. Until then…

Best Regards,

Graham Summers
Editor, Money & Crisis