07.01.2022 – Now they’re pondering again: stock market players are analyzing the Federal Reserve’s minutes. Many assume that the “runoff” – i.e. the normalization of the Fed’s balance sheet through the discontinuation of quantitative easing – could proceed more quickly than previously expected.
Higher interest rates sooner
The consensus in the market is that the minutes turned out to be quite hawkish. The December minutes, now released, illustrate a growing willingness within the Fed for a faster path to higher rates and shrinking the central bank’s balance sheet. The Fed warned of a “potentially faster pace of policy rate normalization.” JP Morgan commented that the Fed sees rate hikes “sooner or at a faster pace” than previously expected.
Faster Tightening
The market also interpreted a fact about balance sheet normalization into the minutes: tightening could begin within nine months. Many had assumed two years after the first rate hike. Moreover, according to the Fed, the U.S. labor market is likely to reach full employment sooner than expected, which would remove one argument for the support provided by the central bank’s flood of money. Otherwise, there is a risk of inflation overshooting.
High-tech and bonds in sell-off
So now interest rate fears and worries about higher financing costs are circulating again. Ergo, growth stocks lost, the Nasdaq Composite slid more than 3 percent yesterday. That’s because higher interest rates are bad news for high-tech stocks, since many newcomers finance themselves through credit; and since companies with no profits usually use the discounted cash flow model for valuation, which incorporates the interest rate. Bitcoin as an inflation hedge dipped. Bonds were also less in demand – those expecting higher interest rates don’t want to lock in long-term at mini-yields. As a result, yields on the ten-year moved up to 1.75 percent.
Not everyone is shocked
The shock is quite astonishing, after all, the meeting of the Federal Open Market Committee was already three weeks ago – and in the meantime, some Fed officials have publicly expressed their views along these lines.
But stoics have also spoken out. Julien Lafargue, Chief Market Strategist at Barclays, commented: “We believe any correction should be relatively short-lived as central banks will be keen to avoid excess volatility. (…) 2022 is likely to be a more challenging year for equity markets as well as investors’ nerves.” Sounds like he just read our short analysis on the VIX trade.
Our conclusion: Fed tightening will be the investment theme this year. Wild swings in both directions can be expected at any time. A paradise for traders. But: don’t trade around the Fed. Keep an eye on real-time news and study our calendar. Whether long or short – Bernstein Bank wishes you successful trades and investments!
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