The Crash Of 2023 Will Be All About These 3 Charts

You would have thought the markets’ performance and the direction of inflation was all about interest rates.

It is not.

It is about money supply. This is roughly the same as the Federal Reserve Balance sheet because its size is the amount of bailouts assets have got from the regulator to keep money supply flushing the system and juicing the economy.

The over-juicing by the world’s central banks to bail out economies ossified in lockdowns is the cause of inflation and to get inflation out of the system that juicy money flood has to be drained.

This is what quantitative tightening (QT) is about; it is reverse quantitative easing (QE). Down goes the Fed’s balance sheet and down goes the market, in the same way as up goes the Fed balance sheet and up goes the market. The reason why this time QE made inflation was that a lot of the money was injected at the bottom of the economic pyramid with a splash, rather than the usual inject at the top to the financially powerful where it dribbles down creating rich man’s inflation on the way down to the ‘real economy’ where there is no shock to hike the cost of a trolley of groceries.

To reverse the trickle down, because you can’t claw back the stimmy checks, the Fed has to run QT and reverse the trickle down that hurts rich man’s assets like stocks and property. QT too much or too long and you get a crash rather than a simply grinding bear market.

So here is a chart of QT provided by the Federal Reserve:

That’s a familiar chart for stock holders.

It’s also likely mixed news, probably bad news, because it should look like this:

I interpret this as the Federal Reserve slowing QT, in this case about $100bn, to stop the market from cracking. No one wants a crash and while strain is fine over time, a discontinuity like a crash creates huge unnecessary costs that can be avoided, which is why the Federal Reserve exists in the first place.

The Fed eased the pain in December and no doubt not to be kind but because it felt very bad things would happen if it didn’t.

So the good news is, the Fed is working to avoid a crash, the bad news is it has pledged to continue to tighten the screws for an extended period of time and that means the direction of travel is down.

When you pull back, the road ahead looks long and gritty:

The trouble is, the world’s government budgets are still drivers of inflation because the fiscal deficits are still a ways from being aligned with inflation targets.

The balancing act, however well played, is still bearish because the road of QT is going to be long because the road of non-trivial inflation levels is also long as is the road to pre-Covid levels of economic equilibrium.

So while this dark cloud hangs over the markets’ future another one shows all is not well in the plumbing of the US financial system.

The reverse repo market is still out of whack.

This chart care of the New York Fed:

You can interpret this in all sorts of ways but to me this is the excess money supply in the system parked by the banks because they can’t use the money. You could say until this is drained away back into the system by the draining of the money at large in the economy by QT, then tightening will continue or need to be increased.

But, if the banks like this cushion but don’t want to lend to the real economy for fear of loss, then this massive reserve of liquidity just freezes and the liquidity in the real economy dries up and the economy crashes.

You might note the Fed slows QT in December and up pops reverse Repo… this is unlikely to be a coincidence.

These two charts and the Nasdaq are the ones to watch, because these are the bellwethers for 2023.