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Federal Reserve Chairman Jerome Powell.
Susan Walsh-Pool / Getty Images
As the economy warms, the Federal Reserve may begin to reduce the size of its bond-buying program by eliminating a layer of support in the stock market.
In the Fed minutes of December, published this week, members of the Federal Open Market Committee highlighted the recent strength of the economy, saying it had shown “resistance to the pandemic.”
The economic recovery has been largely V-shaped. The fiscal incentive is expected to keep consumers and small businesses afloat and ready to spend money and hire workers when the expected millions of doses of Covid vaccines are distributed. -19 – although the distribution was slow. If the economy really recovers as quickly as expected, the FOMC could really get its foot off the gas pedal.
Some on Wall Street are waiting.
Weeks later
City Group
strategies and
Morgan Stanley
economists have exposed the possibility of the Fed reducing the size of its program, Morgan Stanley economists 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 purchased $ 80 billion and $ 40 billion in mortgage bonds each month to keep bond prices high and interest rates low, boosting economic activity. The Fed has said it will continue to do so for as long as the economy needs.
But this is a sensitive issue for investors, not only because the Fed did not provide quantified guidance on when it will change its program, but also because of the “tantic tantrum” memories of 2013. Then the Fed downsized its program. crisis-related procurement, sending higher bond yields and jeopardizing the economy. When the Fed raised rates at the end of 2018,
S&P 500
decreased by 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 range of 0% -0.25%, which it is unlikely to do until at least 2023. Zentner, citing the Fed’s mention of the gradual reduction of in 2013 and 2014, said it is likely to reduce the size of purchases by about $ 10 billion in treasury and $ 5 billion in mortgage bonds in 2022.
If the Fed buys fewer bonds, their prices would be pressured. It is likely that rates, which move in the opposite direction to prices, will increase. Higher interest rates put pressure on stock valuations as they risk being less attractive in stocks against the purchase of safe cash.
Currently, valuations are incredibly high historically due to low interest rates, but if the dynamics of the higher rate unfold, it is likely to indicate a strong economy, indicating rising gains, that could outpace declining valuations. .
Don’t buy stocks if the Fed starts to relax too quickly.
Write to Jacob Sonenshine at [email protected]