Back in September 2012 we forecast that absent major changes, the Fed's security holdings, which then were under $3 trillion, would hit $5 trillion by the end of 2014. One possible "change", and the topic that has consumed the market and pundits over the past month, and led to a spike in equity vol, has been whether or not the Fed will taper its purchases of securities from the current $85 billion per month, to a lesser number, in the process reducing the liquidity "flow" injected into risk assets via Primary Dealers. The prevailing consensus appears to be that Bernanke may trim the monthly number by about 25%, and lower the monthly purchase quota from $85 billion to $65 billion, with an announcement due at the September 18 FOMC meeting. So assuming this is correct, and Ben does as expected, what does this mean? The chart below shows the unprecedented calamity that such as "drastic" move by the Fed would lead to...
The black line is how the Fed's security holdings are projected to grow assuming the status quo; the red dotted line is what would happen in the case of the dreaded Taper: instead of ending up with $5 trillion in AUM at December 31, 2014, Ben Bernanke would have just $4.7 trillion.
Apocalypse now? Because the tiny delta between the black and red lines is what is nowadays seems to be the biggest threat, giving the market daily indigestion and desperately trying to decode with the Fed's presidents are saying at their every public utterance.
So what will happen to stocks when (just kidding) the Fed actually stops, or even begins to reduce its gargantuan balance sheet which is just under 25% of US GDP?