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More concerns for US stocks and bonds: the Fed accelerates the ‘QT’ | Business Section

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

After roughly doubling its balance sheet to $9 trillion post-pandemic, the Fed began unloading some of the Treasuries and mortgage-backed securities it holds in June at a pace of $47.5 billion. of dollars. He announced that he was accelerating the pace of quantitative tightening to $95 billion this month.

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

Some investors, however, are cutting equities or fixed-income securities as quantitative tightening gathers pace, fearing the process will combine with factors like higher interest rates and a rising dollar to weigh more on asset prices and hurt growth.

“The economy is already on a slippery path to recession and the Fed’s quickening QT pace will accelerate the decline in stock prices and the rise in bond yields,” said Phil Orlando, chief strategist stock markets at Federated Hermes, which recently increased its cash allocation to its highest level in 20 years.

The Fed’s monetary policy tightening has weighed on stocks and bonds in 2022. The S&P 500 is down 14.6%, while the benchmark 10-year US Treasury yield, which is moving higher price inverse, recently stood at 3.30%, after jumping 182% points this year.

Although recent data has shown that the US economy has remained resilient in the face of higher interest rates, many economists believe that tighter monetary policy increases the risks of a recession next year.

The New York Fed forecast in May that the central bank would reduce its holdings by $2.5 trillion by 2025.

Estimates vary as to how this will affect the economy: Orlando at Federated Hermes said that every trillion dollars of Fed balance sheet reduction would equal an additional 25 basis points in implied rate hikes. Ian Lyngen, head of US 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 quantitative strategies at Societe Generale, estimates that the Fed will ultimately reduce its balance sheet by $3.9 trillion, which is equivalent to around 450 basis points of rate increases. implicit. The Fed has already raised rates by 225 basis points and another 75 basis point hike is expected later this month.

“It could be QT’s surge that could trigger the markets next drop,” wrote Tadesse, who thinks the S&P could fall to a 2900-3200 range.

Next week, investors will be watching August consumer price data for signs that inflation has peaked. The Fed will hold its monetary policy meeting on September 21.

Jake Schurmeier, portfolio manager at Harbor Capital Advisors, said reduced liquidity due to tighter financial conditions is already making it harder to take large bond positions and will likely contribute to greater volatility ahead.

“It gives us pause before we do anything,” he said. While Schurmeier finds longer-dated Treasuries attractive, he “is hesitant to add more risk until volatility has subsided,” he said.

Timothy Braude, global head of OCIO at Goldman Sachs Asset Management, trimmed his equity allocation in anticipation of greater volatility from the Fed’s quantitative tightening.

“It’s very difficult to say which markets will be hit the hardest,” he said.

Admittedly, some investors doubt that quantitative tightening will have an outsized effect on the markets.

“The increased pace of QT has been known since the Fed announced its QT plans in May,” UBS Global Wealth Management strategists wrote Thursday. “However, when combined with a hawkish Fed, market sentiment is focused on the higher momentum, even if the long-term market impact is not significant.”

The energy crisis in Europe, the pace and duration of Fed interest rate hikes and a possible recession in the United States should outweigh quantitative tightening as market drivers, said David Bianco, managing director. Investments, Americas, at DWS Group.

“We don’t rule out the risks of the QT, but they pale in comparison to the risks of the Fed raising the key rate and how long it has to stay there,” he said.