Russia/Ukraine and Fed Tightening Remain Market Problems

The stock market will continue to be vulnerable to developments in the Russia/Ukraine situation and concerns about the extent of Fed tightening.  President Biden believes Putin has decided to invade, possibly within days.  The FOMC Minutes point to more than 4 rate hikes this year as well as a large reduction in the size of the Fed's balance sheet.  But, comments by some Fed officials, including NY Fed President Williams, suggest the March hike will be only 25 BPs.

The FOMC Minutes were clear on two aspect of the extent of Fed tightening.  Rate hikes would be faster than in 2015-2017 period and that balance sheet reduction would be faster than in the 2017-19 period.  

Specifically, the Minutes said:

1.  Most participants suggested that a faster pace of increases in the target range for the federal funds rate than in the post-2015 period would likely be warranted, should the economy evolve generally in line with the Committee’s expectation. 

 

2.  Participants generally noted that current economic and financial conditions would likely warrant a faster pace of balance sheet runoff than during the period of balance sheet reduction from 2017 to 2019. 

3.  Participants observed that, in light of the current high level of the Federal Reserve’s securities holdings, a significant reduction in the size of the balance sheet would likely be appropriate.

 

The post-2015 trajectory of rate hikes was in 3 steps:  /1/ +25 BPs in 2016, /2/ +75 BPs in 2017 and /3/ +100 BPs in 2018.  (The upper limit of the Fed Funds Rate peaked at 2.5% at the end  of 2018 and stayed there until August 2019 when a series of 3 25-BP cuts began.)  Combining 2016 and 2017, the trajectory points to more than four 25-BP hikes in 2022 and possibly additional hikes in 2023.  These expectations should push up the "dots" chart that will be released at the March 15-16 FOMC meeting.  The prior "dot" chart showed an expectation of 3 rate hikes in 2022.

The monthly pace of Fed balance sheet reduction in 2017-18 was as high as $50 Bn.  Some Street economists are calling for as much as $100 Bn monthly reduction this time.

The stock market rallied strongly over 2017, as the Fed tightening occurred during a speedup in Real GDP Growth (to 2.7% (Q4/Q4) from 2.0% in 2016).  Stocks were range bound for the most part from the beginning of 2018 through the Spring of 2019.   Real GDP Growth slowed a bit in 2018 (to 2.3% (Q4/Q4) from 2.7% in 2017), although there was a more pronounced slowdown from H118 to H218 -- which stopped the Fed tightening.