Fed Balance Sheet vs S&P500

Posted July 2021

Overview

The balance sheet of the Federal Reserve (shown on right axis) has increased very substantially in 2020, and continued at a steady pace throughout 2021. After the Fed cut short term interest rates to zero, there is a very limited amount of actions they can take to further juice the economy. Quantitative Easing is one such action. By expanding its own balance sheet (by buying bonds, and therefore injecting money into the economy), the Fed floods the economy with additional cash, keeping interest rates low and propping up equity markets. For additional information on the relationship between interest rates and stock market prices, see our model on interest rates.

Figure 1 - Fed Balance Sheet vs S&P500
Fed Balance Sheet vs S&P500

The Fed's balance sheet expansion in early 2020 very clearly aligns with the S&P500 crash and subsequent recovery. This suggests that the economy isn't actually doing as well as the S&P500 suggests, and raises serious concern over the sustainability of the current stock market performance. Is additional QE possible?

Additionally, the continuous and aggressive monetary expansion policy necessarily puts pressure on inflation. Via QE, the Fed is injecting new money into the economy. To the extent that the surrounding economy uses the money productively, and grows accordingly, that may not be a bad thing. But excess cash, all else equal, will drive up prices. In 2021, inflation has seen a rapid increase. The Fed has maintained that the increase in inflation is a "transitory" event, i.e., a temporary bump due to pandemic-stimlus and post-pandemic consumer demand increases. Time will tell.

Figure 2 - Inflation 2016 - Present
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Data Sources

The below table cites all data and sources used in constructing the charts, or otherwise referred to, on this page.

Item Source
S&P500 Price Yahoo! Finance S&P500 Daily Close Values
Federal Reserve Balance Sheet Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets (Less Eliminations from Consolidation): Wednesday Level [WALCL], retrieved from FRED, Federal Reserve Bank of St. Louis;