The Concentrated QE Recovery

The following shows the historic rise in the Fed's balance sheet over the past 5 years.

Thus far during the reflation cycle this money has found its way into risk assets, most recently the U.S. stock market. While this process benefits the 1 percent significantly, Fidelity recently reported that over half of their 401k plans have less than $25,600. A major stock market move over the next two years is not going to significantly change these people's lives, or more importantly, their spending habits.

While the large and liquid corporate bond market has seen a tremendous influx of liquidity (specifically junk bonds), small businesses have been shut out of the debt markets. The small business optimism index has remained at depressionary levels since late 2007.

Small businesses contribute the bulk of the hiring in the United States. As they have not had the capital to grow, they have not had the ability to hire. This has led to a "jobless" recovery.

Fortunately many Americans have found a new form of payment; social benefits, also known as income provided by the tax payers. Total government financial assistance is at record highs and continues to move upward. Click for larger image:

I hope it is easy to see that this process is unsustainable. What could derail such a perverse economy? One scenario would be some of the trillions in QE liquidity moving away from U.S. stocks toward commodities. This would put inflationary pressure on the Fed's ability to continue to prop up the artificial asset markets. This may have already begun as commodities, specifically agriculture (food prices), have burst higher to start the year.

The only scenario stopping reckless government spending will be higher interest rates. Like children, only the bond market can force their hand.

Up until this point the Fed has been lucky to have a "perfect" reflation with money focused toward stocks, bonds and real estate (though some would argue that rising housing/rental payments to do not make life easier). If commodities continue to rise while bonds, stocks or real estate begin to roll over, then the Fed will be forced into very a difficult decision. Everyone assumes that food prices will immediately fall if the U.S. economy slows down. This may very well happen, but why is that correlation assumed as a fact? Prices are determined based on global demand, and the world is very hungry. The recent move in the commodity index is below. A preview of what is to come?