Heating Up

With the temperatures rising there have been some interesting developments in the last week.  Utility Stocks, Bonds and Real Estate Investment Trusts(REITS) have run into trouble, pulling back anywhere from 3%-8%. The chief reason is concern from market participants that the improving U.S. economy may force the Federal Reserve to slowly reduce the financial stimulus programs that are in effect. It has been no secret that markets have jubilantly embraced the Fed's intervention.  Even thoughts of a break-up has shaken certain assets in the past week. We made investment adjustments in advance of the latest market concerns and will continue to monitor the markets closely.

One of the questions I often get asked is why hasn't higher inflation become a reality with the significant money-printing the Federal Reserve has undertaken since 2009.  The biggest reason that inflation has not spiked is due to the fact that banks have kept the money in their vaults rather than lend it out.  The chart below shows the total amount of Excess Reserves currently sitting in the largest banks' balance sheets.  Excess Reserves are bank reserves over and above the amount required to be held by regulators.  You will notice that each time the Fed has embarked on a Quant Easing(QE) program that the amount of Excess Reserves has quickly moved higher as banks have "stashed the cash".  When the Fed has been on the sidelines Excess Reserves have fallen.

Unless the large banks begin to significantly increase lending to consumers, this extra money will not find its way into circulation and therefore will have a minimal impact on inflation. It is true at some point the Federal Reserve will need to tighten the money supply, but with a fragile economy they have been hesitant to do so.  If the economy does continue to improve the onus will be on the Fed to tighten and avoid creating a situation similar to 2001-2005 where the Fed's easy money policies led to a host of troubles.

Source: St.Louis Federal Reserve