Minutes from the Federal Reserve's Dec. 14-15 policy meeting signaled an apparent consensus that $4.5 trillion in Covid-era asset purchases unwind at a rate of more than $50 billion per month. The Fed minutes revelation deepened stock market losses. The Dow Jones, S&P 500 and Nasdaq dived as Treasury yields rose and rate-hike odds increased.
XThe stock market was taken by surprise after Fed chief Jerome Powell had provided some assurance about how the balance sheet would unwind at his most recent news conference.
Powell said policymakers had begun to discuss what should happen with the assets accumulated since March 2020 once the tapering of new purchases ends by March. As those trillions in Treasury and mortgage securities mature, the Fed faces a choice. It's whether to let its balance sheet shrink or to roll over the principal, as well as interest, into new purchases.
Why Fed Minutes Surprised Stock Market
Powell indicated policymakers could make a decision in upcoming meetings. While no details were offered, he did offer stock market investors some comforting words. When it comes to the balance sheet, it's "best to take a careful, methodical approach," Powell said, adding that "Markets can be sensitive" about it.
The last time the Fed shrank its balance sheet amid interest-rate hikes, the stock market had a bear-market scare in late 2018. That forced the Fed to call it off and resume balance sheet growth in 2019.
Investors had reacted positively to Powell's overall news conference, sparking a solid rally for the S&P 500 led by tech stocks.
But the Fed meeting minutes had the opposite effect, with intraday losses deepening in a big way after the 2 p.m. ET release.
Key Sentence In Minutes
If there was a killer, it was this sentence: "Many participants judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode."
To recap the last experience with so-called quantitative tightening, or QT, the Fed reduced its balance sheet starting in late 2017 by a pace that grew to as much as $50 billion per month.
Meeting minutes indicated that the strength of the economy, level of inflation and much-increased size of the balance sheet relative to the economy should make for a swifter wind-down.
Just when that wind-down will begin isn't clear. It will probably start on the small side and ramp up. However, the Federal Reserve meeting minutes indicated that "some participants" preferred "to begin to reduce the size of the Federal Reserve's balance sheet relatively soon after beginning to raise the federal funds rate."
January Fed Meeting Stakes Raised
The meeting minutes raise the stakes for the upcoming Fed meeting, Jan. 25-26. Generally, a bigger balance sheet is viewed as better for the stock market. As the Fed unwinds its asset holdings, some potential demand for equities could be diverted to Treasuries and government-backed mortgage securities. The greater supply for bonds might also contribute to higher rates.
In Wednesday action, the 10-year Treasury yield rose to 1.71%, the highest since April. Markets are now pricing in about 75% odds of three quarter-point rate hikes this year.
The Dow Jones, up for much of the session, fell 1.1%. The S&P 500 index slumped 1.9%. The Nasdaq composite tumbled 3.3%.
Make sure to read IBD's daily afternoon The Big Picture column to get the latest on the prevailing stock market trend and what it means for your trading decisions.
Please follow Jed Graham on Twitter @IBD_JGraham for coverage of economic policy and financial markets.
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