Text size
Jerome Powell, Chairman of the Federal Reserve.
Susan Walsh-Pool / Getty Images
As the economy intensifies, the Federal Reserve could reduce the size of its bond-buying program and remove one layer of stock market support.
In the Fed’s December minutes, released this week, members of the Federal Public Market Committee highlighted the recent strength of the economy, saying it had shown ‘resilience to the pandemic’.
The economic recovery was mostly V-shaped. Fiscal stimulus is expected to keep consumers and small businesses afloat and ready to spend cash and hire workers when the millions of expected doses of Covid-19 vaccine are distributed – although the distribution has been slow. If the economy really recovers as quickly as expected, the FOMC could indeed get its foot off the gas pedal.
Some on Wall Street expect it.
Weeks after
Citigroup
strategists and
Morgan Stanley
economists have driven the possibility that the Fed will reduce the program’s size, Morgan Stanley economists wrote in a note Thursday that the possibility is getting closer to reality. Economist Ellen Zentner wrote that the Fed’s minutes mean that “we see the FOMC reducing its asset purchases in January 2022.”
The central bank bought $ 80 billion in treasury and $ 40 billion in mortgage bonds a month to keep bond prices high and interest rates low, boosting economic activity. The Fed has made it clear that it will continue for as long as the economy needs.
But it’s a sensitive issue for investors, not only because the Fed did not provide quantified guidelines on when it’s going to change its program, but also because of the memories of the 2013 “taper tantrum”. has reduced. of its crisis-related purchasing program, to send higher returns and jeopardize the economy. When the Fed raised rates at the end of 2018, the
S&P 500
fell by 16% in less than two months.
The Fed is likely to reduce the size of its program before raising short-term interest rates to the current 0% -0.25% range, which is unlikely to do so until at least 2023. Zentner, referring to the Fed’s announcement of the gradual decline in 2013. and 2014, said it would likely reduce the size of purchases by about $ 10 billion in treasury and $ 5 billion in mortgage bonds in 2022.
If the Fed buys less bonds, their prices will be under pressure. Rates, which reverse to prices, are likely to rise. Higher interest rates push equities’ valuations because it makes the risk of being in equities less attractive than buying safe coffers.
Valuations are currently historically incredibly high due to low interest rates, but if the dynamic higher rate plays out, it is likely to indicate a strengthening economy, indicating growing earnings, which may outweigh declining valuations.
Just do not buy stocks if the Fed starts to lighten too quickly.
Write to Jacob Sonenshine by [email protected]