Investors Are Too Comfortable In The Fed’s Win-Win Conditions For Taking Risk

For a long time, Fed printing via balance sheet expansion has been the key to understanding markets and the predominant driver that has trumped all other matters. Investors have been able to ignore significant global events, tensions, and economic conditions in faraway places, because a lower real and perceived risk premium from implicit Fed promises was the single most important aspect driving asset prices higher. This game is quickly coming to an end.
As the Fed’s asset purchase program ends next month, global events and global economic fundamentals will have to be taken into account and priced accordingly. Investors have become too comfortable and entrenched with the idea that Fed policy provided a win-win condition for taking risk; whereby, weak economic data meant more Fed printing, while strong data meant better fundamentals coupled with a Fed that would (still) only respond slowly and gradually. This cozy arrangement is ending and investors have not yet adequately recalibrated.
Furthermore, at 80:1 leverage, the Fed’s balance sheet is probably close to its practical limit. It stood around 20:1 pre-2008. As it currently stands, should the Republicans take the Senate during the mid-term election in November, criticisms will mount, potentially leading to a major restructuring of the institution.

This post was published at Zero Hedge on 09/30/2014.