Federal Reserve Chair Jerome Powell just told Wall Street that he’s sitting at the controls with his hands firmly on the stick, feeling refreshed and well-caffeinated, and the Fed’s balance sheet isn’t on “automatic pilot,” no sir. Not only that, the plane is coming in for a landing.
Stocks made strong gains Wednesday after Powell told investors what they wanted to hear: The Fed’s balance sheet won’t shrink much further. Investors had seen that as an obstacle to economic growth and more gains for equities.
The S&P 500 finished up 1.5%, extending an earlier increase when the central bank’s rate decision was announced. It then added to gains during Powell’s press conference, breaking out of a recent pattern that saw stocks fall when Powell spoke.
After all, a shrinking of the Fed’s $4 trillion bond portfolio conveys tighter credit conditions. And investors are hypersensitive to anything that might harm the slowing US economy.
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Just six weeks ago Powell suggested the Fed’s balance sheet was shrinking almost by itself, and that it would keep doing so for a long while.
His “automatic pilot” remark helped contribute to a sell-off in stocks over a period of weeks. Investors wanted to feel that the Fed was paying close attention to how its moves affected the market and the US economy. And that’s what the Fed has been trying to tell them ever since.
The Fed now says the balance sheet shrinkage is over, barely a year after it started. In December the Fed suggested it was far from done. It’s a big change in a short time, and its implications aren’t clear.
“This is a watershed moment,” George Goncalves, the head of fixed-income strategy for Nomura’s business in the Americas, said. “What makes the Fed do almost a 180 in six weeks?”
Goncalves said he’s concerned that the Fed is changing its mind because of the market’s sell-off in December, which also tightened financial conditions, or because it’s getting seriously worried the economy might be damaged by external factors like rising trade tensions.
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Guy LeBas, the chief fixed-income strategist for Janney Capital Management, was more upbeat, saying investors are likely to be encouraged by the Fed’s flexible approach. He said the Fed was never likely to reduce its balance sheet to less than $3 trillion.
In the years after the 2007-08 financial crisis, the Fed bought more than $3 trillion in government bonds and other securities to keep interest rates low and aid the recovery of the economy. That purchases were dubbed quantitative easing,” and the shrinking program has been called uncatchy names like “normalization” or “quantitative tightening.”
Whatever it’s called, if the bond purchases made it easier to borrow money, the shrinking balance sheet makes it a bit harder. And investors are hypersensitive to anything that might harm the slowing US economy.