The document discusses the Federal Reserve unwinding its balance sheet and the potential impact. It provides three potential scenarios for Fed unwinding: 1) Good scenario: The 10-year Treasury rises to 2.5%, the S&P 500 increases 12%, and inflation rises to 3.2% as the economy runs hot. 2) Neutral scenario: The 10-year Treasury rises to 2%, the S&P 500 falls 8%, and inflation increases slightly to 2.1% in a slow and steady unwinding. 3) Bad scenario: The 10-year Treasury rises to 2.5%, the S&P 500 declines 35% as unwinding pierces an equity bubble, and inflation increases

1. Fed Unwinding
31 May 2017
War Room

2. War Room
Idea Generation
Contextual Training
Scenario Updates
HiddenLevers runs on SCENARIOS like Facebook runs on PHOTOS

3. The Skinny
Time to Unwind?
What Does Unwinding Look Like?
Scenario: Fed Unwinding
Fed Unwinding
NEW

4. HiddenLevers
THE SKINNY

5. Existential Question
Re-inflate economy of past
or
Accept new economy
forever changed
Fed Scenarios Update
sources: HiddenLevers, Reuters, MarketWatch 1 2
Fed Balance Sheet = 4.5T
Inflationary
Pressures
Biggest hiccup in 2017

6. Fed Unwinding – Let’s take a Look
See it on HiddenLevers

7. Fed Unwinding – Take Aways
Fed can burn
off long term
unemployment
with inflation
Raising rates self-defeating
for Trump Agenda
Balance sheet + S&P
no longer BFF
All market positives point to
inflation

8. HiddenLevers
TIME TO UNWIND?

9. UNWIND: Fed Balance Sheet – Market Impact
Sources: HiddenLevers, Societe Generale
When Fed buys assets, sellers get cash.
Some of that cash makes its way to equities
Treasuries:
Supports federal budget,
enables deficit spending
Mortgages:
Keep mortgage rates down
for housing recovery
Other Assets:
Includes distressed assets
from 2008 bailouts

10. UNWIND: Not your usual rate hike cycle
sources: HiddenLevers
Similarities
Differences
Late cycle moves = less growth
more inflationary
Wage inflation
High correlation between asset classes
Rebalance between workers + capital
Rate hikes likely terminate at 2%
Record U6 unemployment post-crisis
Fed more politicized than ever
Lack of corrections or volatility
Record AUM piling into index funds
Uptick began in late 2016

11. UNWIND: Future positives fuel inflation
Sources: HiddenLevers, Bureau of Labor Statistics
Labor Market:
U-3 = 4.4%
U-6 = 8.6%
Tax Plan:
15-20% Corp
tax rate
Drives corporate
investment +
capital inflows
Infrastructure:
$1 Trillion in
construction
Raises labor +
commodities
demand
Nearing late
1990’s levels of
unemployment
inflation

12. UNWIND: Likelihood of Fed Action
Sources: HiddenLevers, Federal Reserve
Stanley Fischer:
June 12, 2018
Janet Yellen:
Feb 3, 2018
Hawkish replacements = quicker unwinding
Will Trump replacements be orthodox GOP or business minded?
FOMC chopping block
Daniel Tarullo:
Resigned in April

13. HiddenLevers
WHAT DOES UNWINDING LOOK LIKE?

14. FED: Balance sheet + Market Behavior
Sources: HiddenLevers, St Louis FRED
- Increasing Fed Balance Sheet  S&P Growth
- Ending QE  Market Dip. Could Unwinding  Market Dip?
QE2 QE3QE1
Taper Tantrums

15. Shrink Money Supply = Equities Fall?
Sources: HiddenLevers, Bloomberg
Fed tried to shrink money supply in 1937, with
disastrous results for equities
S&P 500 Change vs Money Supply

16. FED: Raising Rates = Self Defeating?
Sources: HiddenLevers, Brookings
Large-scale asset purchases were undertaken because,
with interest rates nearly at zero, conventional
interest-rate cuts wouldn’t suffice
If conventional rate cuts were insufficient on the way
down, why should we expect conventional rate hikes
to suffice on the way back up?
record tax receipts in 2016
infrastructure paid by deficits
lowering taxes paid by deficits
govt has to pay interest on that

17. HiddenLevers
SCENARIO: FED UNWINDING

18. SCENARIO: Fed Unwinding
10y Treasury
1.8%
S&P 500
-35%
10y Treasury
2.5%
S&P 500
+12%
$
CPI
2.8%
CPI
3.2%
10y Treasury
2.0%
S&P 500
-8%
CPI
2.1%
GOOD
NEUTRAL
economy
runs hot
slow +
steady
UGLY
pierce equity
bubble

19. Fed Unwinding – Take Aways
Fed can burn
off long term
unemployment
with inflation
Raising rates self-defeating
for Trump Agenda
Balance sheet + S&P
no longer BFF
All market positives point to
inflation

20. Fed Unwinding – Let’s take a Look
See it on HiddenLevers