The declines in Wall Street stock markets last night are attributed to the hawkish tone of the Fed as it emerged from the Open Market Commission Protocol (FOMC) from its last meeting. The committee that convenes before each interest rate announcement to formulate a decision on the monetary policy of the US Federal Reserve, not only wants to bring forward interest rate hikes next year by 3 beats since March, but also for the first time in a while discusses the bank’s balance sheet To the markets – which in other words constitutes a tightening of monetary policy more aggressively than might have been thought so far.
A rise in US interest rates this coming March has already been priced in the market, but not a reduction in the Fed’s balance sheet. . The start of the Fed’s balance sheet reduction is expected to reduce liquidity in the markets, leading investors to digest that the Fed has indeed switched sides on the record, but the music may be jarring to interest – sensitive risk assets. Following the publication of the protocol, the market switched to pricing an increase in the interest rate by a quarter of a percent in March, with a probability of about 80%.
The Fed is trying to avoid a recession as reflected in the yield curve of the bond market. The yield curve represents the difference between the yields given to investors by short-term bonds and those provided by long-term bonds. All investors look at the gap between the two-year bonds and that of the 10-year bonds. Usually the return to investors in the long run is higher than the return in the short run, so the curve tends to climb up. Recently, the yield gap has narrowed at a rapid pace since 2011.
Expectations of an early rise in the interest rate have pushed up short-term bond yields, but long-term bonds have weakened due to the “bet” on a mistake in the Fed’s policy that raising interest rates will moderate inflation, when raising interest rates is not reflected By the market in the longer term. Raising the interest rate can be a weapon against inflation, but may also lead to a slowdown in economic growth by raising the cost of loans and any interest-linked property.
The bank has accumulated $ 8 trillion in bonds as a result of the quantitative easing it has provided to the market. Has expanded liquidity in the markets, now it will reduce it. The move comes with the intention of bringing about an increase in the long-term interest rate, thus narrowing the gap with the short one.
If the market has a bitter taste of the Fed’s reversal of 180-degree inflation, since Fed had hints that it was not temporary even when it reached over 5% a few months ago, today no one is talking about it but the steps they will take. Fed including the fear of making a policy mistake. In 2018, Powell’s interest rate hikes reversed the yield curve, the Fed’s interest rate hikes at the time Ben Bernanke in 2006 also reversed the yield curve, and here in 2008 Governor Fischer was forced to raise interest rates in the midst of the subprime crisis. .
The sensitivity of the markets to inflation is the story of the markets in 2022
The spread of the omicoron makes it difficult for decision-makers to change policies even though the labor market is tight and inflation is rampant, precisely when trying to frame the ultra-expansionary policy that was activated even more with the outbreak of the corona crisis. U.S. President Joe Biden has appointed Powell to a second term to fight rising inflation in the U.S., and Powell has not remained obligated, and after the appointment called for abandoning the term ‘temporary’ regarding inflation. But while temporal has become fixed, inflation may escalate upwards as a result of world supply disruptions with the spread of the omicron and any discussion of temporary or permanent will seem like history.
Point of light: Given that stocks have fallen in isolation to a certain economic value but in response to the central bank’s tone when inflation is the main story in the markets in 2022, it is not inconceivable that if market declines continue, the Fed or any of its spokesmen will express Need before the midterm this avalanche on Wall Street. On the other hand, for the same reason that inflation is the story in the markets, in the economy and especially in the public, and given the rapid change in inflation policy, the reduction of the balance sheet may also turn very quickly from talk to action.