Courtesy of Pam Martens
Photo of the Trading Floor at the New York Fed (Obtained by Wall Street On Parade from an Educational Video Despite Stonewalling by the New York Fed)
To understand how the U.S. central bank, known as the Federal Reserve, is influencing the froth of the stock market, you need to take a few moments to understand the interaction of bond yields with stock prices. Sophisticated investors who predominate in the markets compare the yield on bonds to the cash dividend yield on stocks to determine which is a better value. Following the financial crash of 2008, the Federal Reserve began buying up Treasury bonds and mortgage-backed bonds in the marketplace to the overall tune of more than $3 trillion. This has driven down bond yields and provided an artificial boost to the stock market.
The Fed’s assets swelled from $914.8 billion at the end of 2007 to $4.5 trillion in 2014 from its bond buying program. In just the single year of 2013 the Fed’s assets mushroomed by a staggering $1 trillion — from $2.9 trillion at the end of 2012 to $4 trillion at the end of 2013, according to the audited financial statement of the Fed’s books. As of October 25, 2017, its assets remain in the $4.5 trillion arena, at $4.461 trillion.
The Fed’s active involvement in messing with the stock market as a fair stock pricing mechanism through its massive purchases of bonds was quaintly called Quantitative Easing (QE) and the public was treated to three doses of it: QE1, QE2 and QE3.
Since 2011, the Fed has been jawboning about how it was going to normalize its balance sheet back to something resembling pre-crisis days. It actually began to cut back its bond purchases by shrinking the amount of its maturing bonds that it will roll over into new bond purchases in October of 2017. But its scheduled cuts are so small and gradual that we are not seeing any material shrinkage in its assets.
During Fed Chair Janet Yellen’s September 17, 2014 press conference, in response to a question from Ylan Mui of the Washington Post, Yellen said: “If we were only to shrink our balance sheet by ceasing reinvestments, it would probably take—to get back to levels of reserve balances that we had before the crisis—I’m not sure we will go that low, but we’ve said that we will try to shrink our balance sheet to the lowest levels consistent with the efficient and effective implementation of policy—it could take to the end of the decade to achieve those levels.”
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