The Federal Reserve may have to do more than just issue dovish guidance to stabilize the stock market.
It may have to halt or wind down its balance sheet normalization process.
Right now, $50 billion worth of bonds are rolling off the Federal Reserve’s balance sheet every month, which at one point swelled to a staggering $4.5 trillion after multiple rounds of quantitative easing stimulus conducted in the aftermath of the 2008 financial crisis. Prior to the financial crisis, the Fed’s balance sheet held under $1 trillion worth of assets.
“The balance sheet unwinding is far more impactful than rate hikes in terms of being disruptive to markets,” said Kristina Hooper, Invesco’s chief global market strategist, in an interview with Yahoo Finance.
Hooper thinks the Fed should dial down its normalization process to a more palatable $10 billion or $20 billion monthly roll off.
By roll off, the Fed is essentially allowing $50 billion worth of bonds to mature per month (instead of using those proceeds to buy more bonds), thus reducing the overall size of its bond holdings.
“When you get to $50 billion per month, you start to experience the cumulative effects over time,” she said.
After all, the S&P 500 (^GSPC) is down 12.6% from its Sept. 20 closing high of 2,930.75, eclipsing the traditional definition of a correction.
“The Fed views financial stability as part of its mandate — It’s not just about inflation and employment,” Hooper said.
And the seemingly quiet balance sheet roll-off over the past few months that was supposed to be as exciting as “watching paint dry,” as former Fed Chair Janet Yellen once said, has been anything but quiet.
Experts attribute the recent wave of volatility to the liquidity-suck driven by the Fed’s balance sheet shrinkage.
“Recall what happened in January 2016 after the Fed raised rates in December 2015,” said Nomi Prins, author of Collusion: How Central Bankers Rigged the World, to Yahoo Finance. “The markets fell both because they feared the loss of easy liquidity and because that loss would exacerbate economic and credit problems.”
The year 2016 was the worst start to a new year for stocks ever.
Prins thinks a halt or slowdown of the monthly bond roll offs is on the table should the S&P 500 continue its fall.
The $50 billion figure appears to have caught the attention of President Trump, who continued his months-long criticism of current Federal Reserve policy on Tuesday in a tweet.
“I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers,” Trump tweeted. “Good luck!”
Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.
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