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Fed Tapering and What it Means for Markets: Video and Transcription

With the Federal Reserve's 2021 economic symposium coming up soon, how will Fed Tapering from the COVID-19 pandemic affect the markets? Robert Knight, Head Trader at offers his educated opinion in this video and full transcription.

It's August 25th, 2021. The SPY is up 0.19% today. It did trade to nominal new highs while it is trading at all time highs. And this is so strong, this huge, huge move in the SPY continues to be so. I coined a term yesterday, T.I.N.A. There Is No Alternative. I mean, there's just the Mega Cap. Stocks are going crazy now. What we're looking for though is perhaps, as the Fang stocks and such, the mega cap stocks, start to get fairly valued, that we'll get a switch into some of the other stocks we're trading. And actually we're starting to see some sectors really taking off. And in particular today, we see biotechs going. So that's encouraging for the stocks that we trade.

I did want to talk a bit about today as well about the fed meeting coming up in Jackson Hole. So what they're going to discuss there is the ongoing tapering of the bond purchase asset purchased by the Fed. So they've been talking about this since March, maybe more so around June. So the market has already priced in comments to come from the fed about tapering. It's probably by the end of 2022, tapering will be completely finished, but we don't really need the economic stimulus anymore because the markets themselves or, the economy has recovered very strongly. So Fed Tapering. What does that mean? The quantitative easing. They put money into circulation to keep interest rates low. So they buy the bonds and with strong demand in bonds, interest rates go down, prices go up.

So the Fed buys the bonds. In a sense, it's just moving from one hand to the other. But they are two different parts of the puzzle. They put money into the system by buying these bonds, and that keeps interest rates low, but it also fuels a lot of things. And one of them is inflation, which we've seen. Now, the Fed is saying that inflation is transitory and that because we were so beat up in the pandemic, there's bound to be a rebound, but it's not going to be consistent. They're still looking for a target of 2%, even though inflation year over year, it did spike to between four and 6%. There's an old saying that if rates go from 0.25% to 0.5%, that's up a hundred percent, but in real terms, it doesn't mean anything.

So, you know, if you get inflation going from zero or negative to 6%, obviously that's a huge pop, but it's not unmanageable. It's not out of the range that you might expect when you get a strong recovery. So Feds: expect them to say that rates will remain unchanged that the bond market, that they'll continue to taper. This is all already priced into...I mean, I don't make this stuff up and just say it....I read what other people much smarter than I am are saying. And so, you know, this is the market sentiment. I mean, look how strong this market is. It's just crazy, but T.I.N.A. There Is No Alternative.

The MDX here is flat on the date, but it had treated to all do it. I mean, look at the big surge. This took three days up now. Maybe needs to consolidate a bit in here, but it did bounce off the 50. We noticed that on the SPY as well, every time the market trades off the 50, it bounces. And this also coincides with the Mcclellan oscillator, getting into an extreme oversold position. Now, it seems to be pretty consistent, this pullback, but it does make higher lows. So obviously big, strong, rising channel. The DOW is up 0.23 here this morning also bounced off the 50 bounce off the trend line, maybe coming into the apex of a wedge. Trannies up 0.58. This is consolidating in here. ...

So let's look at the ETFs that we follow. The financial sector popping out here, trading back almost all time highs. ... just a dollar short of all time highs. If this busts out...this is going to trade to... You could actually look to add. This is a big reverse head and shoulders pattern. Maybe a cup and handle would be a better way to describe it. Here's your cup. Here's your handle. That's a major breakout. So what this is also indicating for markets is that we could expect with the Feds tapering, we could expect interest rates to firm up from up from their current levels, even though the Fed is going to hold interest rates near zero, the bond market itself will start to price in, a bit higher interest rate.

And this is good for the banks. Banks make much more money with higher interest rates. It's not necessarily good for the economy, but if you have a very strong economy, you can handle higher rates--not a lot higher, but still, under 1%, it's still such cheap money. You can borrow money all day long at 1%, and you should be able to repay that. The problem with higher rates though, is that the Fed with such a huge debt now putting on trillions and trillions of dollars to the pandemic, kinda love rates to go too high because they need to pay them back and they need to pay the interest on the bonds.

So if rates go up, that could be detrimental to the bond. The Fed is trying to maintain a liquid balance sheet because they have to roll bonds come due. So if you sell bonds to the market at 0.25% or 0.5%, that's your rate of interest that you have to pay for the length of the bond. Now, if that bond is a five-year bond or a two year bond, then you're fine. But when you roll that, you need to go to the market to fund your government. And if the 0.25 comes due after two years, you have to go back to the market to replace that. And if rates are much higher, the Feds are going to run into some trouble, trying to maintain their interest payments. That'll take up a big chunk of their budget.

There are some other big, strong economic theories about the US dollar being the world currency, and that actually is one of the biggest exports that the US has is their dollar. It's much too difficult, in the short period of time that we have here, to talk about what that all means. Suffice it to say that because that's their biggest export, there will be demand to buy US dollars. And so in buying US dollars, it quite often is shown in the purchase of bonds, the US treasuries. Though the Fed may be tapering their buying because the US exports so much us dollars, there still will be may be not as much pressure on markets to price the Fed bonds higher (US treasuries) because there's such a big demand for US dollars vis-a-vis the bond market. So what does that all mean? It means that markets are going higher. The bull market is well in place, and we should see it continue to go. That's my theory. And I'm sticking to it.


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