The Fed Drained $4B From Its Balance Sheet Last Week


The yield on the U.S. Treasury 10-Year Note rose to 2.614% on April 17 and then dipped to 2.549% on April 18. The rise in yield was likely caused by the reduction of $4 billion in U.S. Treasuries for the period ended on April 17. Most likely, the Federal Reserve allowed the $4 billion to roll off of its balance sheet by not reinvesting the proceeds from Treasuries that matured on April 15.

In my opinion, this "quantitative tightening" has a negative impact on economic growth, as money leaves the banking system. Fed officials say that it does not. President Trump agrees with my premise and is responding by nominating Stephen Moore and Herman Cain to the Federal Reserve Board. The president wants two like minds to counter problems he sees in the policy choices made by Fed Chair Jerome Powell. You just can't take billions and billions out of the banking system without hurting the economy.

The balance sheet is now marked at $3.932 trillion, down $568 billion from the $4.5 trillion peak at the end of September 2007.

My Fed call remains the same: The Federal Open Market Committee (FOMC) will leave the federal funds rate at 2.25% to 2.50% through 2019 and potentially until the end of 2020 after the presidential election. The Fed will continue to drain the balance sheet through September 2019, but this will amount to a pause, not an end to quantitative tightening.

Reviewing the Federal Reserve balance sheet strategy: The Federal Reserve will stop the unwinding at the end of September 2019. The Fed has set an unwinding schedule of $50 billion in April and then $35 billion for each of the next five months through September. This would take the balance sheet down to $3.731 trillion, which would not meet Chairman Powell's stated goal of a $3.5 trillion balance sheet. An additional $231 billion will likely be scheduled after the 2020 election.

The daily chart for the yield on the 10-Year U.S. Treasury Note

The daily chart for the yield on the U.S. Treasury Note shows that this yield rose to 2.614% last week after trading as low as 2.340% on March 28. The yield closed last week at 2.549%. My quarterly value level is 2.759%, with my monthly and semiannual pivots at 2.576% and 2.605%, respectively. These pivots were magnets last week. This week's risky level is 2.458%.

The weekly chart for the yield on the 10-Year U.S. Treasury Note

The weekly chart for the yield on the 10-Year U.S. Treasury Note shows the decline in yields that began from a high yield of 3.261% set during the week Oct. 12 as the stock market peaked. This yield held its 200-week simple moving average, or "reversion to the mean," at 2.356% during the week of March 29. The bond yield closed last week just below its five-week modified moving average at 2.569%. The 12 x 3 x 3 weekly slow stochastic reading rose to 32.01 last week, up from 25.41 on April 12. 

Daily chart for the SPDR S&P 500 ETF (SPY)

The SPDR S&P 500 ETF (SPY) closed the shortened trading week on Thursday, April 18, at $290.02, 24.1% above its Dec. 26 low of $233.76 and is just 1.3% below its all-time intraday high of $293.94 set on Sept. 20. My monthly and semiannual value levels are $272.17 and $266.14, respectively, with my weekly and annual pivots at $288.99 and $285.86, respectively, and my quarterly risky level at $297.56.

Weekly chart for the SPDR S&P 500 ETF (SPY)

The weekly chart for the SPDR S&P 500 ETF is positive but extremely overbought, with the ETF above its five-week modified moving average at $283.00 and above its 200-week simple moving average, or "reversion to the mean," at $239.98 after this average held at $234.71 during the week of Dec. 28. The 12 x 3 x 3 weekly slow stochastic reading rose to 94.52 last week, up from 92.77 on April 12 and up from 90.70 on April 5, moving further above the overbought threshold of 80.00. SPY remains in an "inflating parabolic bubble" condition with a reading above 90.00.

How to use my value levels and risky levels: Value levels and risky levels are based upon the last nine weekly, monthly, quarterly, semiannual and annual closes. The first set of levels was based upon the closes on Dec. 31. The original semiannual and annual levels remain in play. The weekly level changes each week; the monthly level was changed at the end of January, February and March. The quarterly level was changed at the end of March.

My theory is that nine years of volatility between closes are enough to assume that all possible bullish or bearish events for the stock are factored in. To capture share price volatility, investors should buy shares on weakness to a value level and reduce holdings on strength to a risky level. A pivot is a value level or risky level that was violated within its time horizon. Pivots act as magnets that have a high probability of being tested again before their time horizon expires.

How to use 12 x 3 x 3 weekly slow stochastic readings: My choice of using 12 x 3 x 3 weekly slow stochastic readings was based upon backtesting many methods of reading share-price momentum with the objective of finding the combination that resulted in the fewest false signals. I did this following the stock market crash of 1987, so I have been happy with the results for more than 30 years.

The stochastic reading covers the last 12 weeks of highs, lows and closes for the stock. There is a raw calculation of the differences between the highest high and lowest low versus the closes. These levels are modified to a fast reading and a slow reading, and I found that the slow reading worked the best.

The stochastic reading scales between 00.00 and 100.00, with readings above 80.00 considered overbought and readings below 20.00 considered oversold. Recently, I noted that stocks tend to peak and decline 10% to 20% and more shortly after a reading rises above 90.00, so I call that an "inflating parabolic bubble," as a bubble always pops. I also refer to a reading below 10.00 as "too cheap to ignore."

Disclosure: The author has no positions in any securities mentioned and no plans to initiate any positions within the next 72 hours.

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