Expectations are high for the Federal Reserve to outline its plans next week to start providing less monetary aid to markets.

But what if the Fed on Wednesday, after its two-day Federal Open Market Committee meeting, pulls the trigger and starts slashing its monthly pace of $ 120 billion in bond purchases?

“Obviously, a ton of cash has already been poured into the market, and some parts of the fiscal stimulus haven’t even been distributed yet,” Tony Bedikian, head of global markets at Citizen Bank, said during a telephone interview.

Against this backdrop, Bedikian said stocks should be supported by continued risky trading next year, although the Fed also begins to slightly raise key interest rates from the current 0% to 0.25 range. %.

He also predicts that the US economy will continue to recover from the coronavirus pandemic and grow, as the Fed takes a step back, especially if consumers continue to spend and no “fears” emerge on the front lines. COVID – unless high inflation gets in the way.

“We continue to be concerned about high inflation,” Bedikian said. “If it continues to be so, the Fed may need to increase more aggressively to help bring inflation down.”

Inflation: gains, pains

Low interest rates are designed to stimulate lending by banks in times of crisis and borrowing by businesses and individuals.

The addition of large-scale bond purchases by central banks to the mix provides an anchor, lowering bond yields and causing increased demand for stocks and other financial assets.

“The whole thing is a shock to the system,” said Stephen Dover, chief market strategist at Franklin Templeton and director of his investment institute. “Right now, reserve banks continue to buy more instruments,” but maybe less of them on the road. “This does not mean that in the short term, they reduce what they already have. “

This is also why things have become controversial. Billionaire hedge fund manager Bill Ackman joined a growing chorus of market heavyweights on Friday urging the Fed to step down.

See: Bill Ackman says “The Fed should cut immediately and start raising rates as soon as possible

The Fed has been buying bonds for 19 months now, and its balance sheet has roughly doubled to a record $ 8.6 trillion. This chart shows how difficult it has been for the Fed to reduce its market footprint, even modestly, since it started buying bonds after the 2008 global financial crisis.

The Fed’s balance sheet was less than $ 1,000 billion in 2008

Federal Reserve Board

Without extraordinary monetary policy measures, known on Wall Street as quantitative easing (QE), Societe Generale analysts estimate the S&P 500 SPX index,
+ 0.19%
would be closer to 1800.

To verify: How Much of the Rise in the Stock Market Over the Last 11 Years Is Due to QE? Here is an estimate

The S&P 500 closed on Friday at a new high at 4,605 ​​while the Dow Jones Industrial Average DJIA,
+ 0.25%
and Nasdaq Composite Index COMP,
+ 0.33%
also sunk deeper into record territory. The Big Three are up 90 to 125% from their March 2020 lows, according to Dow Jones Market Data.

“There is definitely a connection between quantitative easing and the great appreciation we have seen in the stock market,” Dover said, while also noting that fixed income investors have struggled with low returns.

“It dramatically widened the wealth gap,” he said, hurting “retired people who invested everything in fixed incomes or middle class people” who did not own stocks. from 2008 and beyond. Many of these people also face a higher cost of living.

“The reserve bank almost seems to be there to support the owner of the asset,” he said.

See: The US economy stumbles in the third quarter

Low interest rate assessment

Besides stocks, the Fed’s emergency pandemic policies have also supported the US real estate market and big business.

Low 30-year mortgage rates and the construction shortage since the last housing crisis have skyrocketed US home values ​​to $ 37.1 trillion in the second quarter, an astonishing 45.5% increase from the previous quarter. peak before the 2006 crisis, according to the Urban Institute.

For large US companies, the benchmark 10-year Treasury yield TMUBMUSD10Y,
1.560%
climbed over the past three months, but still ended October at 1.555%, well below the Fed’s 2% inflation target, well below the current inflation rate more than 5%, and only about 40 basis points above its 12-month low in January, according to Dow Jones Market Data.

In 2021, U.S. businesses continued the historic borrowing frenzy of last year to take advantage of low interest rates, even as profits roared. Rinsed with money, they’re also in pencil this year for a torrent of $ 1,000 billion in stock buybacks, which Democrats want to tax to help find social spending programs.

When do easy money policies end? Wall Street believes that high inflation will prompt the Fed to raise interest rates faster than its dot plot projections suggest (see chart).

Fed funds rate never exceeded 2.5% after 08 crisis

Oxford economy

But Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, finds supply chain bottlenecks pushed up goods prices in mid-2022, causing interest rates to slow. directors at 1.5%.

For those aspiring to higher bond yields for income, that would still be about 1% below the level where federal funds rates peaked after 2008, the longest period of economic expansion in U.S. history. .