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Expect Quant. Tightening Soon; Equities Can Fall Fast

The alleged recession of 2022/2023 has been one of the most anticipated financial events that has yet to materialize.  However, recent macros data and events support the expectation that the U.S. Federal Reserve and its international counterparts will turn to quantitative tightening to fight inflation.

As Lawinfo has been writing, the macros data indicates strong labor market, despite large tech layoff headlines, and stubbornly strong housing prices, hurting affordability.

Inflation data has reaccelerated in January 2023 and February 2023.  The most recent PCE data was 5.4% January 2023 increase over January 2022.  This broke the downward trend of the previous three reports of 6.1%, 5.6% and 5.3% for October – December 2022.  The CPI shows a similar trend, on a month over month basis.  January 2023 was a 0.5% month over month increase, versus the previous monthly downtrend of 0.5, 0.2, 0.1.   Meanwhile, the industrial production index for January was strong, 103.  The jobs report yesterday, March 10, 2023, showed 311,000 new jobs, in the face of a very slight uptick in the unemployment rate to 3.6% from 3.4%.

Again, inflation up, strong economy.  No recession yet.

Meanwhile, housing permits, a forward looking metric, have declined from a one-year peak of 1.9 mm in May 202, to a steady number of approximately 1.3 mm since November 2022.

When we compare this data to the M2 money supply and the Federal Reserve Balance sheet; the driver of the strong economy and inflation appear clear.  The Federal Reserve put far too much money into the system.  That money was used to purchase assets.  Those asset prices are inflated.  This exacerbates inflation, due to the wealth effect.

For any reasonably educated person, if the Federal Reserve wants to be successful at fighting inflation, it must shrink its balance sheet, and the money supply.

In the face of lost credibility, Lawinfo thinks the Fed will get serious about regaining credibility.  The Fed will augment its interest rate increases, with quantitative tightening.  Lawinfo expects that this will mean the Fed will sell asset, thereby shrink its balance sheet and reducing the supply of money.  Investors will sell all asset classes and create a general asset valuation decline.  Lawinfo thinks that crypto will be particularly negatively impacted.

The charts support this forecast.

M2 is at extraordinarily high levels, despite recent interest rate increases.








Long term, the current M2 Supply is Unprecedented and provides a significant explanation for extended, excessive inflation.








The Federal Reserve exploded its balance sheet to deal with COVID.







The explosive growth of the Fed Balance Sheet in 2022, was from already high and growing levels.

Meanwhile, the forward-looking housing permits data has shrunk.

Lawinfo expects the money supply to decrease, and asset prices to fall.  Particularly weak should be crypto currency, as interest rates increase.  Ironically, housing may remain relatively robust due to chronic shortage of supply.  Equities may sell-off rapidly in the next few months, with potential downside as much as 25% to 30% lower on indices.

Due to the inherent uncertainty in these predictions, Lawinfo will look to trim, add cash, and wait for a bottom to put money into high beta, and tech leaders, when we opine we are near a bottom.

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