After the financial crisis of 2008, the Federal Reserve found itself in a very difficult position in terms of its ability to protect the U.S. economy. Many of the traditional rules has to be rewritten, and the central bank embarked on a long-term program of quantitative easing (QE) in order to rectify matters. As the economy continues to strengthen, many of these measures are no longer needed and the Federal Reserve is set to reduce its balance sheet into 2019. But key questions remain, and many investors are wondering if these actions to be taken by the Fed will ultimately weigh on stock markets.
In this chart, we can see that quantitative easing began in 2008 and rose steadily in all of the world’s major economic regions. The Federal Reserve was actually somewhat conservative in this respect (relative to the actions taken by the European Central Bank and the Bank of Japan), but this would not be readily apparent if we only read the financial news headlines in the United States.
At the same time, the Fed is expected to be the most aggressive central bank in terms of its tightening programs going forward. Fed Chair Jerome Powell has made it clear that accommodative monetary policy is no longer needed, and that it is time to shrink the balance sheet to levels that are more normalized on an historical basis. The Fed’s tightening program is expected to move swiftly into the final parts of 2018, pause a bit, and then begin again with aggressive tightening into the middle of 2019.
The biggest impact will be seen in the number of Treasury securities which are held by the Federal Reserve. Mortgage-backed securities will also be reduced by a substantial amount (but not to the same degree). Under its current schedule, the Fed acted to reduce its balance sheet by $20 billion per month during the first quarter of 2018. This figure increased to $30 per month during the second quarter of 2018 and the trend continued during the third quarter (at $40 billion per month). During the fourth quarter, the Federal Reserve is expected to reduce its balance sheet at a pace of $50 billion.
Overall, the Fed’s quantitative easing programs are clearly being phased-out, and this will continue at an increasingly aggressive pace over the next few years. Of course, there are risks to these projections, and we could see deviations if the growth outlook for GDP is materially weakened in the quarters ahead. Rising debt levels suggest that this remains a possibility, so it is important for investors and consumers to remember that these projections may still change if economic surprises occur in the future.
These trends are important to watch, as they can have a significant impact on interest rates and stock market valuations – and these are all factors which have a strong effect on the real consumer economy. The Federal Reserve holds a strong position in this regard. But it is up to consumers to monitor their finances (and their investments) in protective ways as these broader market trends continue to unfold.
Article By: Ric Cox