December FOMC Minutes delivered a hawkish surprise to financial markets. The Federal Reserve (Fed) of the United States hinted at rate hikes and quantitative tightening (QT).
After the 2008-2009 Great Financial Crisis, central banks in the developed world eased their monetary policies to the extreme. Not only that they lowered the interest rates to zero or below, but they also innovated.
One of the most controversial programs born in the aftermath of the Great Financial Crisis is quantitative easing or QE. An unconventional measure involves buying government bonds to provide liquidity to the financial system.
To many, QE is nothing but money printing. It creates inflation, people argue, hence the lack of popularity. However, it helped bring back economies from recessionary conditions after the 2008-2009 Great Financial Crisis and during the COVID-19 pandemic.
This week, the FOMC Minutes revealed more details about the Fed’s intentions. The minutes showed a more hawkish Fed ready to hike the federal funds rate after tapering ends and reverse QE. So basically, instead of QE, the Fed will do quantitative tightening or QT.
What does it mean for US stocks?
Quantitative easing boosted stocks
Any form of easing helps risky assets such as the stock market. For example, aggressive easing, such as the one triggered by the COVID-19 pandemic, led to the US stock market rising to record levels. In fact, during all the QE programs the Fed ran in the last years, the stocks rallied.
Logic tells us that the opposite should happen during periods of QT.
It is not the first time that the Fed will do QT. During Janet Yellen’s mandate, the Fed started a QT program designed to shrink the size of its balance sheet. It all went smooth, but then another crisis came, and QE was back on the table.
To sum up, bidding for stocks in a period of QT is not wise. It does not mean that stocks will enter bearish territory, but it does signal that the stock market may underperform in 2022 after rallying in 2021. The more aggressive the Fed is in its tightening cycle, the bigger the impact on risky assets – stocks included.
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