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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 downsize its bond-buying program by removing a layer of stock market support.
In the Fed minutes of December, released this week, members of the Federal Open Market Committee highlighted the recent strength of the economy, saying it showed “resistance to the pandemic.”
The economic recovery has been mostly V-shaped. The fiscal stimulus is expected to keep consumers and small businesses more afloat and ready to spend cash and hire workers when the millions of planned doses of Covid- vaccines are distributed. 19, although distribution has been slow. If the economy really recovers as quickly as expected, it is possible that the FOMC will take its foot off the gas pedal.
Some on Wall Street are waiting for it.
Weeks later
Citigroup
strategists i
Morgan Stanley
economists raised the possibility of the Fed downsizing its program, Morgan Stanley economists said yesterday in a note that is approaching 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 has been buying $ 80 billion in finance and $ 40 billion in mortgages a month to keep bond prices high and interest rates low, boosting economic activity. The Fed has made it clear that it will continue to do so as long as the economy needs it.
But this is a sensitive issue for investors, not only because the Fed has not given quantified guidelines on when it will modify its program, but also because of the memories of the “rage” of 2013. That was when the Fed reduced the size of their crisis-related purchasing program, sending higher 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 range of 0% -0.25%, which is unlikely to do so at least until 2023. Zentner, citing the 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 and $ 5 billion in mortgage bonds by 2022.
If the Fed buys less bonds, their prices would be pressured. Rates, which move inversely to prices, are likely to rise. Higher interest rates put pressure on stock valuations because they make the risk of being in stocks less attractive if you buy safe-haven securities.
Currently, valuations are incredibly high historically due to low interest rates, but if higher rate dynamics develop, it is likely to indicate a strong economy, indicating rising gains, which could offset the fall in valuations.
Don’t buy stocks if the Fed starts to decline too quickly.
Write to Jacob Sonenshine to [email protected]