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More worries for U.S. stocks, bonds: Fed ramps up 'QT'

Economy Sep 09, 2022 09:30PM ET
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By David Randall

NEW YORK (Reuters) - As the Federal Reserve accelerates the unwinding of its balance sheet this month, some investors worry that so-called quantitative tightening may weigh on the economy and make this year even more brutal for stocks and bonds.

After roughly doubling its balance sheet to $9 trillion after the pandemic, the Fed began unloading some of the Treasuries and mortgage-backed securities it holds in June at a pace of $47.5 billion. It has announced that this month it is ramping up the pace of quantitative-tightening to $95 billion.

The scale of the Fed’s unwinding is unprecedented and the effects of the central bank ending its role as a consistent, price-insensitive buyer of Treasuries has so far been hard to pinpoint in asset prices.

Some investors, however, are cutting back equities or fixed income as quantitative tightening accelerates, wary that the process could combine with factors such as higher interest rates and a soaring dollar to further weigh on asset prices and hurt growth.

"The economy is already in a glide path to recession and the Fed's quickening pace in terms of QT will accelerate the decline in stock prices and increase in bond yields," said Phil Orlando, chief equity market strategist at Federated Hermes (NYSE:FHI), who recently increased his cash allocation to a 20-year high.

The Fed's tighter monetary policy has weighed on stocks and bonds in 2022. The S&P 500 is down 14.6%, while the yield on the benchmark 10-year U.S. Treasury, which moves inversely to prices, recently stood at 3.30%, after surging 182 basis points this year.

Although recent data have shown the U.S. economy has remained resilient in the face of higher interest rates, many economists believe tighter monetary policy is increasing the chances of a recession next year.

The New York Fed projected in May that the central bank will shave $2.5 trillion off its holdings by 2025.

Estimates vary for how this will affect the economy: Orlando, at Federated Hermes, said every $1 trillion in Fed balance sheet reduction would equate to an additional 25 basis points in implicit rate hikes. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, estimates it could add up to 75 basis points through the end of 2023 alone.

On the other end, Solomon Tadesse, head of North American Quant Strategies at Societe Generale (OTC:SCGLY), believes the Fed will ultimately cut $3.9 trillion off its balance sheet, equating to about 450 basis points in implicit rate increases. The Fed has already raised rates by 225 basis points and another 75 basis point increase is expected later this month.

“It could be the ramp-up in QT that could trigger the next fall in markets,” wrote Tadesse, who believes the S&P could drop to a range of 2900-3200.

Investors next week will watch August consumer price data for signs inflation has peaked. The Fed will hold its monetary policy meeting on Sept. 21.

Jake Schurmeier, a portfolio manager at Harbor Capital Advisors, said reduced liquidity from tightening financial conditions is already making it more difficult to take large bond positions and will likely contribute to more volatility ahead.

"It gives us pause before we make any moves," he said. While Schurmeier finds longer-dated Treasuries attractive, he is "hesitant to add more risk until volatility has dampened down," he said.

Timothy Braude, global head of OCIO at Goldman Sachs (NYSE:GS) Asset Management, has been reducing his equity allocation in anticipation of more volatility due to the Fed's quantitative tightening.

"It's very hard to tell which markets are going to be the most affected," he said.

To be sure, some investors doubt quantitative tightening will have an outsized effect on markets.

“The increase in the pace of QT has been known since the Fed announced its QT plans in May,” strategists at UBS Global Wealth Management wrote on Thursday. “However, when combined with a hawkish Fed, market sentiment focuses on the higher pace even though the impact to the marketplace over the long term is not material.”

The energy crisis in Europe, the pace and duration of the Fed's interest rate hikes, and a potential U.S. recession are likely to trump quantitative tightening as market drivers, said David Bianco, chief investment officer, Americas, at the DWS Group.

"We’re not dismissing the risks of QT but they pale in comparison to the risks of where the Fed hikes the overnight rate and how long they have to stay there," he said.

More worries for U.S. stocks, bonds: Fed ramps up 'QT'
 

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Comments (5)
Kerry Ditto
Kerry Ditto Sep 10, 2022 12:30PM ET
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QT, quantitative tightening is even stronger than rate hiking. stock market got big problems, double troubles. current situation is much worse than Paul Volcker Era.
Joe Rizzuto
Joe Rizzuto Sep 10, 2022 7:40AM ET
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the fed is almost done. the market has seen the low. common sense will win in the midterms. america will be great again. putin will be dead. buy! hurrry!
Dennis Chuck
Dennis Chuck Sep 10, 2022 7:40AM ET
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Id-iot
Joeri Willems
Jurinho Sep 10, 2022 7:40AM ET
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not this time. winter is coming.
Kris Jay
Kris Jay Sep 10, 2022 1:37AM ET
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when was the last time the Fed cut balance sheet by 2.5-3.5T????  everyone on Friday who drove up prices on market OK with QT?   or do you figure you will get out in time before the crash?
Mathias Willems
Mathias Willems Sep 10, 2022 1:37AM ET
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qt and rates going up have a delayed effect, ultimatly profits will drop but november december are good months for the stock market, i would keep cash after, say somewhere january cash out maybe or start setting tight selling points. take a look at sqqq then.
Mathias Willems
Mathias Willems Sep 10, 2022 1:37AM ET
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the market still is way too high but inflation ending might give us one more bull run is my opnion
Joe Rizzuto
Joe Rizzuto Sep 10, 2022 1:37AM ET
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you sound like a limited thinker
David Beckham
David Beckham Sep 09, 2022 10:25PM ET
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Only all in long to the moon
Dr Snuggels
Dr Snuggels Sep 09, 2022 10:25PM ET
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You is aso from Indonesia?
jason xx
jason xx Sep 09, 2022 10:20PM ET
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fud alert.
 
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