The Great Unwinding

Words of elegance rarely fall from the lips of many T.V. financial commentators as they report events that revolve around the world of business news. That’s not their job. Their task is to report financial news in a concise and factual manner, which for the most part they do extremely well.

However, I was quite surprised today when a Financial commentator on the Fox Business Network called and I believe coined the upcoming massive liquidation of the Fed’s $4.5 Trillion-dollar balance sheet as “The Great Unwinding.”

Referred to as the process of quantitative “normalization” by many Fed Members, the liquidation of the Fed balance sheet, acquired throughout the many years of quantitative easing, will begin in October. It will start with the monthly liquidation of Fed Assets totaling $10 billion, and be raised each quarter by $10 billion until they reach a monthly cap of $50 billion. It will remain there until the Fed has completed the process.

The Federal Reserve announced yesterday that they would, in fact, implement one more interest rate hike in December. However, just as importantly, they announced the initiation of their process to liquidate the massive $4.5 trillion balance sheet as early as next month, with the initial liquidation of $10 billion.

One of the results of yesterday’s Fed announcement was gold prices dropping below $1300 for the first time since September. In fact, over the last two days, gold futures have lost over $22 per ounce and are currently trading at $1294.

As reported in MarketWatch, Adrian Ash, head of research at BullionVault said, “The hot money was betting on lower for longer from the Fed. Now it’s shocked that [Fed Chairwoman] Janet Yellen’s team have repeated what they announced back in June about letting [quantitative easing] ease back from next month.” 

It must be realized at yesterday’s announcement covers more than just a simple interest rate hike on the Fed’s dot plot. The process of liquidation of the Fed's asset sheet has also been termed a “stealth rate hike,” in that the net effect liquidation will be to raise interest rates.

Letting bonds mature without repurchasing them changes the basic supply and demand of these bonds available in the marketplace. The lower a bond is priced is a direct reflection of the interest paid on those financial instruments.

Of course, higher return (interest rates) in bonds become more desirable relative to gold investments that do not yield interest. Another net effect of higher interest rates is that this action is typically supportive of the US dollar, and since gold is a dollar-priced commodity it will move inversely to any upside move in the US dollar.

Investors and market participants have gone through multiple interest rate hikes by the Fed, so this is nothing new. However, the “great unwinding” which will begin next month contains uncertainty. Never in the history of the Federal Reserve have they acquired such a massive balance sheet, nor have they moved towards a process of liquidating that balance sheet.

Wishing you as always, good trading,