Text size
Federal Reserve President Jerome Powell.
Susan Walsh-Pool / Getty Images
As the economy heats up, the Federal Reserve may begin to downsize its bond-buying program by removing a layer of support from the stock market.
In the Fed’s December minutes, released this week, members of the Federal Open Market Committee highlighted the recent strength of the economy, saying it showed “resilience in the face of the pandemic”.
The economic recovery was mainly in the form of V. The fiscal stimulus is expected to keep consumers and small businesses more than afloat and ready to spend money and re-hire workers when the millions of expected doses of Covid-19 vaccines are distributed. – although the distribution was slow. If the economy really does recover as fast as expected, the FOMC may indeed take its foot off the accelerator.
Some on Wall Street expect this.
Weeks later
Citigroup
strategists and
Morgan Stanley
economists have considered the possibility of the Fed reducing its program size, economists at Morgan Stanley wrote in a note on Thursday that the possibility is becoming closer to reality. Economist Ellen Zentner wrote that the Fed’s minutes mean “we see the FOMC reducing its asset purchases starting in January 2022.”
The central bank has been buying $ 80 billion in Treasury bills and $ 40 billion in mortgage bonds a month to keep bond prices high and interest rates low, stimulating economic activity. The Fed made it clear that it will remain so as long as the economy needs it.
But this is a sensitive issue for investors, not only because the Fed did not give quantified guidance on when it will change its program, but also because of the memories of the 2013 “tantrum”. It was when the Fed reduced the size of its program crisis-related buying behavior, increasing bond yields and putting the economy at risk. When the Fed raised rates in late 2018, the
S&P 500
fell 16% in less than two months.
The Fed would likely reduce the size of its program before raising short-term interest rates above the current 0% -0.25% range, which is unlikely to do until at least 2023. Zentner, citing the Fed’s mention of its gradual reduction in 2013 and 2014, said it is likely to reduce the size of purchases by about $ 10 billion in Treasury bills and $ 5 billion in mortgage bonds in 2022.
If the Fed buys fewer bonds, its prices will be pressured. Rates, which move inversely to prices, are likely to increase. Higher interest rates put pressure on stock valuations because they make the risk of being in stocks less attractive against buying safe Treasury bills.
Valuations are currently incredibly high historically because of low interest rates, but if the dynamics of higher rates occur, it is likely to indicate a steady economy, indicating growing gains, which could outperform falling valuations.
Just don’t buy stocks if the Fed starts to loosen too quickly.
Write to Jacob Sonenshine at [email protected]