By STAN CHOE
NEW YORK (AP) — The tremor hitting Wall Street is not just due to the slowdown in the Federal Reserve’s money printer that is supporting markets, but that it could soon reverse.
With inflation high and the economy strengthening, the Fed has warned investors that the ultra-easy conditions it has created for them in recent years are likely to disappear. It appears on track to raise short-term interest rates sooner and more aggressively than expected, and it may also soon start shedding some of the trillions of dollars in bonds it has purchased since the start of the crisis. pandemic.
While the first possibility would be negative for Wall Street, this is something investors are preparing for. The second possibility, however, came as a surprise when it was included in the minutes of the Fed’s last policy meeting, which were released on January 5. Fed Chairman Jerome Powell raised the possibility again during testimony on Capitol Hill on Tuesday.
The last time the Fed trimmed its massive bond portfolio and raised short-term rates in tandem, the S&P 500 fell nearly 20% in three months to the end of 2018. It only recovered. ‘after Powell’s abrupt pivot in January. 2019 by declaring that the Fed would be “patient” in its policy of withdrawing part of the stimulus measures that it had injected into the markets.
“These are the flashbacks the market is having right now, and one wonders how long it will be before the punch bowl is really taken out – and should investors be positioning themselves for that right now,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.
Such fears are already manifesting in mortgage rates which rose for a third straight week to an all-time high as the pandemic first froze the economy.
The average for a 30-year loan was 3.45%, down from 3.22% last week and the highest since March 2020, Freddie Mac said in a statement Thursday. Rates followed a jump in yields for the closely watched 10-year Treasuries, which rose to levels not seen since the start of 2020, before the pandemic rocked financial markets. Cheap loans have helped fuel a housing recovery that is still going strong even as house prices soar out of reach for many Americans.
“The rise in mortgage rates so far this year has yet to affect buying demand,” Freddie Mac chief economist Sam Khater said in the statement. “But given the rapid pace of house price growth, this will likely dampen demand in the near future.”
Imagine a borrower who can afford a mortgage payment of $2,000 per month. At the January 2021 record low of 2.65%, that $2,000 payment nets the borrower $496,000. At this week’s rates, $2,000 covers a loan of $448,000, almost 10% less.
On Wall Street, investors have only recently become accustomed to the idea of the Fed simply scaling back its monthly bond purchases. Since the start of the pandemic, the central bank has been creating money to buy bonds in hopes of keeping long-term interest rates low and stimulating the economy. This practice is called “quantitative easing” by economists. More colloquially, this is called “printing money”.
Bond purchases and record short-term rates near zero have helped drive up market prices in recent years. It also made investing particularly easy, with relatively shallow scary areas spoiling the big returns. Along with a suite of easy-to-use trading apps, it has helped attract a new generation of investors to the market. Their reward? If they just bought an S&P 500 index fund and sat there last year, they gained almost 30%.
But now, instead of just a “reduction” in buying, as the Fed is on track to end bond purchases in March, markets are expecting a sharp shift to “quantitative tightening”.
After the publication of the Fed minutes, for example, economists at BNP Paribas raised their expectations that the Fed would announce quantitative tightening until July and start it in August. Earlier, they predicted a spring 2023 debut.
At Deutsche Bank, economists say the Fed could cut $300 billion to $400 billion from its balance sheet in the second half of 2022. It could cut another $1 trillion in 2023, which would have about the same effect as two hikes. short-term interest rates. rates.
“We will have the ability to act sooner and act a little faster than we did last time,” Powell said of quantitative tightening on Tuesday. “More clarity will come soon on this.”
The last time the Fed started shrinking its balance sheet, it waited nearly two years after its first interest rate hike. This time it could be in a few months.
Asked by a U.S. senator whether the Fed will simply allow bonds to mature and roll off its balance sheet or take the extra step of actually selling bonds, Powell said no decision has yet been made. was taken.
The Fed didn’t last time, but Powell said the conditions were different this time. For one thing, the Fed’s balance sheet is trillions of dollars larger than it was last time. Inflation is also much higher this time around, with Wednesday’s Consumer Price Index report showing a 7% jump from levels a year ago.
“And the economy is much stronger,” Powell said. “It’s a very different situation.”