Many were stunned at the pace of the v-shaped recovery in US equity markets this week after Monday and Tuesday's carnage. However, as the following chart makes very clear, there was good reason for it... Having overshot to the downside of "Fed-Balance-Sheet-Implied" levels but around 100 S&P points, the broad index ripped back higher to almost perfectly settle at "Fed Fair Value" - between 1980 and 2000. But, there is a rather ominous event occuring in 2016 that is out of The Fed's control that implies S&P 1,800 unless QE4 is unleashed.
Fed balance sheet implies an S&P level around 1990...
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What happens next? Well, Scotiabank's Guy Haselmann has some thoughts...
The Fed's balance sheet has $400 billion of maturities to deal with in early 2016 which the market place is not paying enough attention to.
I believe the Fed will want to allow as much of this as possible to roll off (i.e. the balance sheet will shrink). The decline in the Feds balance sheet is a defacto tightening.
The Fed may be reluctant to do both, i.e. hike, while also allowing the balance sheet to shrink too quickly. They could hike and do some re-investment, but it may be strange re-invest a large portion at the same time that they are hiking.
I believe market turmoil and balance sheet maturities will cause a period of (hike) pauses in 2016. If this is true, Treasury market yields may not rise as high as some pundits are warning.
A $400 billion reduction - which is inevitable unless The Fed unleashes a new QE - means S&P drops to 1800... and further...
Charts: Bloomberg
