The U.S. Federal Reserve aggressively started to buy assets on their balance sheet to stimulate asset markets in the wake of the Great Financial Crisis. The Fed has always used U.S. Treasury Bonds and Bills to help control the money supply and interest rates.
But the tendency in recent years is to use this additional tool during times of extreme duress to add liquidity to financial conditions. All may know the size of the balance sheet adds significant liquidity to asset markets and has the intended consequence of inflating market valuations by suppressing yields. The U.S. Federal Open Market Committee expects to shrink the balance sheet by several trillion in the coming year to add additional tightening to financial conditions.
Bond yields have started to move up in anticipation of higher for longer monetary policy and the bond supply pressure coming from both deficit financing and QT. The Congressional Budget Office forecasts that public debt will be 46 trillion by 2033 at about 119 per cent of GDP versus 26 trillion and 98 per cent today. The percentage that interest costs impacts the annual deficit is projected to continue to grow. To put it simply, the fiscal outlook is a significant headwind for economic growth.
Do not believe for a minute that MSFT and AAPL should be trading at 30x plus multiples were it not for the abundant liquidity the central banks have created despite what Wall Street analysts would have you believe with their AI growth stories. They are both great companies, they are just hugely overvalued today.
Believe central banks when they say they are serious about fighting the inflation they helped create from inflating their balance sheets. Believe that less globalization, rebuilding supply chains and an aging workforce demographic will likely add inflationary pressures. Believe that aging and shrinking populations like Japan, China and Germany are deflationary. Believe the cost of debt financing will need to be monetized by larger central bank balance sheets.