The Federal Reserve (FED) Is Worrying Market With 3 Threats From Policy Tightening
Investors were bracing for the Federal Reserve to begin raising interest rates. They also know that central bank is cutting amount of bonds it buys each month. They also predict that ultimately, the cuts will result in a reduction of nearly $9 trillion. in assets held by Fed. What they didn’t expect was that all three things happened at same time.
In Fed’s meeting, announced on Wednesday, it was indicated that may be case.
The meeting summary shows that members are ready to not only raise interest rates and reduce bond purchases, but also engage in a high-level conversation about reducing holdings of Treasuries and covered securities. by mortgage.
Favorable for anti-inflation
The moves are beneficial to combating inflation, and as job market recovered, Fed’s triple tightening policy sent markets into a tailspin on Wednesday. The result was stocks rallied and then another as the hawkish central bank hid uncertainty about the investment landscape.
The reason market had such a jerky reaction yesterday was that it looked like Fed was going to move fast and furious and pull liquidity out of market. If they do it steadily and slowly, market can do well in that situation. Otherwise, that would be a different story.”
Still, prospect of a much more positive Fed is cause for concern after nearly two years of most accommodative monetary policy in history.
Alternatively, investors may be worrying too much about policy from officials, who have made it clear they don’t want to do anything to slow recovery or weaken financial markets. .
“Indeed, market won’t have to wait long to see where Fed is going.”
Chairman Jerome Powell will speak next week in his confirmation hearing. Michael Yoshikami, founder and president of Destination Wealth Management, said Powell will get another chance to tackle markets after Fed’s January 25-26 meeting, when he can deliver a more peaceful speech.
One key factor that Yoshikami sees is that while Fed is determined to fight inflation, Fed will also have to deal with the omicron impact: “I hope Fed will come out and say that everything is based on the pandemic. is exploding. But if omicrons really continue to be an issue for the next 30 or 45 days, it will hit the economy and possibly put us on hold.”
Beyond that, there are some policy certaintys: For example, market knows that Fed starting in January will only buy $60 billion in bonds a month (half amount it bought a few months ago). ).
So what market doesn’t know right now is how drastically Fed will shrink its balance sheet. That’s an important issue for investors as central bank liquidity has helped underpin markets during times of Covid volatility.
Federal Reserve reduces amount from bonds
In its most recent accounting, from 2017 to 2019, Fed allowed a reduction in limit on amount of money earned from bond portfolio. Capitalization starts at $10 billion per month. Then increase by $10 billion quarterly until it reaches $50 billion. By the time Fed had to pull out, it had just $600 billion left from its $4.5 trillion balance sheet.
Estimates after Wednesday’s news ranged from a $100 billion cap at JPMorgan Chase to $60 billion at Nomura. Fed officials have yet to specify any numbers.
Another possibility is that Fed could sell off assets, said Michael Pearce, senior US economist at Capital Economics.
There are many reasons for a central bank to do so, especially given its so low perennial interest rates, the Fed’s relatively long-term bond record, and absolute size of its balance sheet that is close to folding. double compared to last time.
“While longer-term yields have rebounded in recent days, if they continue to stay low and Fed is facing a rapidly flattening yield curve, there could be a good case that Fed should completely replenish its balance sheet.
That leaves investors with a myriad of possibilities that could make navigating 2022 landscape difficult. Fed waited, and this time, policymakers seemed determined to move things forward faster.