Markets should brace for a turbulent few weeks as slow motion rate shock continues, DataTrek says
Reuters/Carlos Barria
- Stocks could be in for more Fed-induced turbulence, according to DataTrek research.
- That's partly because the Fed is unlikely to stop its quantitative tightening regime.
- The Fed has reduced its balance sheet aggressively over the past year, which could weigh on stocks.
The stock market is reacting poorly to August's run-up in interest rates after key bond yields spent most of this year trending lower in response to the outlook the Federal Reserve is likely close to being done raising interest rates.
According to DataTrek though, investors should buckle up for even more choppiness ahead.
That's because even after the Fed stops hiking interest rates, there's another policy tool the central bank can use to keep tightening monetary policy: quantitative tightening, the central bank's practice of reducing its balance sheet to dry up liquidity in markets and tighten financial conditions.
What's more, the Fed is running off its balance sheet at a time when the US is issuing massive amounts of new debt, with plans to sell $1 trillion of Treasury bonds this quarter alone.
As of last week, the Fed has already reduced its balance sheet around $700 billion from the first quarter of 2022, down to $8.2 trillion from $8.9 trillion. Aggressive balance sheet tightening was one of the factors that weighed heavily on stocks last year, with the S&P 500 shedding 20% to notch its worst performance since 2008.
"By refocusing the market's attention on stubbornly high inflation, the Fed is implicitly telling us that they are comfortable keeping their current pace of balance sheet reduction for quite some time," DataTrek co-founder Nicholas Colas said in a note on Thursday.
The Fed is unlikely to stop its quantitative tightening regime even after it's done hiking interest rates, Colas added, and markets should be prepared for disappointment when it comes to a possible "Fed put".
"Thinking the Fed will step in to fill the breach, either by easing up on balance sheet reduction or going back to bond buying, seems wishful at best," Colas said. "The current slow-motion long-term rate shock has a way to go, in our view, and equity markets will struggle as it evolves. All this fits with our belief that we're in for a sloppy few weeks ahead.
The yield on the 10-year Treasury note traded at 4.28% on Wednesday, notching ts highest level in 15 years.