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Economic Insights

So far, risk assets have shrugged off the U.S. Federal Reserve’s intermittent moves to scale back monetary accommodation. Will that trend continue as the Fed steps up its efforts? 

Many investors, financial professionals, and market commentators have asserted that the end of the extraordinary monetary support offered by the U.S. Federal Reserve (Fed) and other major central banks would spell doom for risk-asset prices. (One example is a monitory Bloomberg headline from August 21:  “Fed's Big Bond Unwind May Clobber U.S. Stocks, Corporate Debt.”1) The worriers assert that the Fed’s low-rate regime and its bond purchases under its quantitative easing program were the primary drivers of asset-price appreciation in the past several years; once the proverbial policy punch bowl is drained, that support will vanish.

But less-accomodative Fed policy has been on the radar of investors for more than four years. Since May 2013, the Fed’s policy-setting arm, the Federal Open Market Committee, has:

  • Announced that it was contemplating ending asset purchases (May 2013).
  • Started tapering asset purchases (January 2014).
  • Stopped purchasing assets completely (October 2014).
  • Ended forward rate guidance (mid-2015).
  • Raised rates (December 2015).
  • Raised rates again (December 2016).
  • And again (March 2017).
  • Announced it was contemplating shrinking the fed’s balance sheet (May 2017).
  • Raised rates one more time (June 2017).
  • Announced that balance sheet shrinkage would begin (September 2017).
  • Asserted that rate increases and balance sheet shrinkage could take place simultaneously (September 2017).

Throughout this process, U.S. markets have more or less believed that most of these actions were of the “one and done” variety, or that the Fed would not be able to implement them at all. For example, the fed funds futures market currently is assigning a probability of only 32% to two rate hikes by June 2018, according to Bloomberg.

What has happened to key risk assets and economic indicators since former Fed chairman Ben Bernanke’s first intimation in May 2013 that the Fed would begin tapering? Through September 21, 2017, U.S. stocks have had a total return of 71.8%, and the U.S. high-yield market has returned 25.5%. Spot gold is up 0.3%, while the most popular gold exchange-traded fund is down 14.1%. The U.S. Consumer Price Index has risen by a cumulative 5.6%.

The main point here is not that monetary tightening is good for risk asset prices. It’s that many other things that influence the economy—fiscal policy, technological developments, corporate profit margins, etc.—matter a lot too. The Fed’s actions during the financial crisis of 2008–09 surely provided support for risk assets. But they didn’t completely cancel the effects of all the negative events (e.g., adverse economic and financial-system developments) that were happening. More recently, the Fed’s actions have actually hurt stock and bond prices without canceling all the positive things (e.g., steady economic growth, improving labor conditions) that are happening.

If the Fed continues withdrawing monetary support at a measured pace, which in itself is sensitive to the current state of the U.S. economy, there is every reason to believe that the dire outcomes predicted and acted upon by many formerly brilliant-seeming investors can be avoided. 

 

1Rich Miller and Sally Bakewell, “Fed's Big Bond Unwind May Clobber U.S. Stocks, Corporate Debt,” Bloomberg, August 21, 2017.

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