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Federal Reserve Chairman Jerome Powell.
Susan Walsh-Pool / Getty Images
As the economy heats up, the Federal Reserve may begin to scale down its bond buying program, removing a layer of stock support.
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 had shown “resilience in the face of the pandemic.”
The economic recovery has been mostly V-shaped. The fiscal stimulus is expected to keep consumers and small businesses more than afloat and ready to spend money and rehire workers when the expected millions of doses of Covid-vaccine 19 will be distributed – although distribution has been slow. If the economy really does recover as quickly as expected, the FOMC may indeed take its foot off the accelerator.
Some on Wall Street expect it.
Weeks after
Citigroup
strategists and
Morgan stanley
Economists have raised the possibility of the Fed scaling back the size of its program, economists at Morgan Stanley wrote in a note Thursday that the possibility is getting closer to reality. Economist Ellen Zentner wrote that the Fed minutes mean that “we see the FOMC reducing its asset purchases from January 2022”.
The central bank purchases $ 80 billion in treasury bills and $ 40 billion in mortgage bonds per month to keep bond prices high and interest rates low, stimulating economic activity. The Fed has made it clear that it will continue doing this as long as the economy needs it.
But this is a sensitive issue for investors, not only because the Fed has not given figures on when it will change its program, but also because of memories of the “taper tantrum” of 2013. C That’s when the Fed downsized its crisis-linked buying program, pushing bond yields up and putting the economy at risk. When the Fed raised rates at the end of 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% to 0.25% range, which it is unlikely to do until at least 2023. Zentner, citing the Fed’s mention of its phase-out in 2013 and 2014, said it would likely reduce the size of purchases by around $ 10 billion in treasury bills and $ 5 billion in mortgage bonds in 2022.
If the Fed buys fewer bonds, their prices will come under pressure. Rates, which move inversely with prices, are likely to increase. Higher interest rates put pressure on stock valuations because they make the risk of being in stocks less attractive compared to buying safe treasury bills.
Valuations are currently incredibly high historically due to low interest rates, but if higher rate dynamics do manifest, they are likely to indicate a firming economy, indicating growth in profits, which could outweigh the decline in valuations.
Don’t buy stocks if the Fed starts to ease too quickly.
Write to Jacob Sonenshine at [email protected]
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