Breaking News
Investing Pro 0
Ad-Free Version. Upgrade your experience. Save up to 40% Upgrade now

Analysis-Investors brace for quantitative tightening as Fed sends hawkish message

Economy Jan 06, 2022 06:22
Saved. See Saved Items.
This article has already been saved in your Saved Items
© Reuters. FILE PHOTO: Flags fly over the Federal Reserve Headquarters on a windy day in Washington, U.S., May 26, 2017. REUTERS/Kevin Lamarque/File Photo

By David Randall

(Reuters) - Another barometer of Federal Reserve hawkishness is making a bigger appearance on investors’ dashboards: quantitative tightening.

Minutes from the Fed's December meeting released on Wednesday showed that officials had discussed shrinking the U.S. central bank’s overall asset holdings as well as raising interest rates sooner than expected to fight inflation, with "many" judging the appropriate pace of the Fed's balance sheet reduction would be faster this time.

Investors said the hawkish signal bolsters the case for those who believe the central bank will need to act more decisively in order to contain inflation, and could fuel further bets on higher yields while continuing to shake up the growth and technology shares that powered last year’s dynamic stock rally.

“There’s a real risk that the Fed is being too aggressive here,” said Scott Kimball, co-head of U.S. fixed income at BMO Global Asset Management, who reduced his positions in high yield corporate bonds and private debt late last year, believing they will underperform as rates rise.

“If the Fed is reducing its presence in the market at the same time that its policies could choke off growth, that’s a pretty big walloping,” he said.

Stocks extended declines after the release of the minutes on Wednesday, led by a selloff in technology and growth shares. Bond yields, which move inversely to prices, rose, with the benchmark U.S. 10-year yield rising to its strongest level since April 2021.

Higher yields tend to weigh on some stocks, particularly growth names, because they threaten to erode the value of future earnings.

The Fed kicked off the taper of its $120 billion per month purchase of government bonds in November. A month later, it said it would aim to wrap up the taper by March rather than its mid-year target, and its “dot plot” showed a more aggressive path for rate increases than investors were expecting. That led some to wonder whether the central bank might start contemplating outright balance-sheet reductions as another tool to combat surging inflation.

Fed Chair Jerome Powell said after the December meeting that while policymakers hadn't decided when balance sheet run-off would start, "those are exactly the decisions we will be turning to in coming meetings."

Some analysts had anticipated the move. Analysts at TD said in a research note that they are short 10-year real rates as the market begins to price in balance sheet runoff, saying the current rate of nearly -1% was inconsistent with higher Fed rates and a shrinking balance sheet.

Ten-year real yields, Treasury yields that adjust for expected inflation, jumped to -0.8% on Wednesday.

The U.S. yield curve, meanwhile, flattened following the Fed minutes, after steepening the last two session, indicating investors are bracing for rate hikes that push short-term rates higher.

However, analysts at Citi said the accelerated time-line of balance-sheet runoff could see curve-steepening over the medium-term "as the balance-sheet vs rate hike pace debate stirs."

While the Fed held its balance sheet in a steady state for about three years after beginning its taper in 2014, soaring consumer prices now may mean that the Fed will need to be more aggressive in reducing its over-$8 trillion balance sheet this time around.

Futures on the federal funds rate on Wednesday afternoon, following the release of the Fed minutes, priced in a roughly 80% chance of a quarter-percentage-point rate increase by the Fed at its March policy meeting.

“The fact that the balance sheet was discussed, and in more detail than we thought, sets the market up for possibly four rate hikes this year, and perhaps starting as soon as March,” said Kim Rupert, managing director of global fixed income analysis at Action Economics. “They are very afraid of inflation getting out of hand.”

Jason Ware, partner and chief investment officer for Albion Financial Group, believes broader equity markets may still rise under a more hawkish Fed, but expects more volatility and a rotation into economically sensitive companies.

"There is going to be some changes under the surface of the indexes," Ware said.

Analysis-Investors brace for quantitative tightening as Fed sends hawkish message

Related Articles

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind: 

  • Enrich the conversation
  • Stay focused and on track. Only post material that’s relevant to the topic being discussed.
  • Be respectful. Even negative opinions can be framed positively and diplomatically.
  •  Use standard writing style. Include punctuation and upper and lower cases.
  • NOTE: Spam and/or promotional messages and links within a comment will be removed
  • Avoid profanity, slander or personal attacks directed at an author or another user.
  • Don’t Monopolize the Conversation. We appreciate passion and conviction, but we also believe strongly in giving everyone a chance to air their thoughts. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at’s discretion.

Write your thoughts here
Are you sure you want to delete this chart?
Post also to:
Replace the attached chart with a new chart ?
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (1)
David Hawley
David Hawley Jan 06, 2022 6:51
Saved. See Saved Items.
This comment has already been saved in your Saved Items
But isn't inflation self adjusting? consumers do not have an endless supply of money to continue paying ever increasing prices. sooner or later demand is going to drop off...and this drop off starts now, not all at once in a year's time. However, stock market investors will jump ship at any suggestion there MIGHT be a hole in the hull. and then try to clamber back on board as the ship sales away.
Are you sure you want to delete this chart?
Replace the attached chart with a new chart ?
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
Sign up with Email