Fed Balance Sheet, Operation Twist, Yield Curve & Gold

I was poking around nftrh.com’s links page (it is extensive) and (re)discovered Macro Trends and its wealth of charts and data. For me, looking at pictures works better than looking at raw numbers. Always has.

This picture for example illustrates what we used to think we knew about gold’s relationship to the Fed’s ballooning balance sheet. It was as easy as buy gold and keep up with the Fed’s off the charts inflationary operations… until it wasn’t. The Fed kept pumping and pumping until the economy finally responded, to the detriment of gold.

In late 2011 the Fed announced Operation Twist, which was a brilliantly evil (my opinion) macro manipulation of epic proportions. The racket was to sell short-term US Treasury bonds and buy long-term US Treasury bonds which, by definition would drive the yield curve to a flattening and paint two things into the macro as short-term interest rates were implied to rise vs. long-term interest rates.

Thing 1: A low risk atmosphere by which conventional casino patrons could simply operate as if all was well (it had to that point been very unwell).

Thing 2: Inflation was not a concern, bloated Fed balance sheet or not.

Gold went on the outs for the most dynamic phase of balance sheet expansion as the economy did recover (ref. our 1st real signal in January 2013 in the Semi Equipment industry’s firming and then ramping book-to-bill ratio) while the Fed kept pumping monetary policy in the form of said balance sheet expansion and ZIRP (Zero rate policy) nearly 2 years after the 2yr yield had signaled it was time to normalize policy.

But Bernanke kept the pedal to the metal and the monetary metal stayed on the outs, the economy caught on to the degree that even economists had to finally come around and start cheer leading, a fiscal policy making reflator was elected and it was happy ever after time for the Good Ship Lollypop.

But… the distortions. You don’t get something for nothing and things balance out eventually. I won’t pretend to know what form that balancing will take, but speaking of “balance”, the Fed’s balance sheet is slowly being normalized as is the Funds Rate. Again, by way of Kevin Muir we review this graphical combo (QT & Fed Funds) of policy tightening that has already hit a caution point (at best).

Maybe we will even find out before long what the results of the Bernake Fed’s injected distortions will be.

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