Will tapering and tightening rain on the parade?

  • The Federal Reserve discussed raising rates sooner than alluded to before, although increases still are not anticipated until 2023.
  • This may apply pressure to certain stock market sectors.
  • The economic recovery has solid momentum and earnings expectations continue to trend higher.

Rate hikes may come sooner than expected

This June, the Fed signaled that they expect to be making two interest rate hikes by the end of 2023. This contradicts their past guidance that such moves wouldn’t be in the works until 2024.

A rise in interest rates can have a cooling effect on economic growth, as it raises the cost of borrowing. This move, according to Chairman Powell, would potentially be made if inflation turns out to not be as transitory as expected.

It’s a “talking about talking about” kinda thing

The Fed controls the supply of money within the banking system through Open Market Operations.

  • The central bank issues, or sells, bonds to raise funds for projects. This decreases the amount of money in the banking system and rates interest rates.
  • When the central bank buys bonds, it injects money into the economy and forces interest rates down.            

The Fed has announced it may curtail its bond buying, although Chairman Powell softened the statement by categorizing the conversation as “talking about talking about” taking the action. We’ll hear further on this subject in the end of August after the Kansas City Fed’s Jackson Hole summit. It is possible this is a sign of tapering off and the end of stimulus activity.

In the meantime, we’ll be thinking about thinking.  

Possible effects of policy shift

Overall the economy is currently in a strong position with the recovery fully underway and earnings expectations on the rise. In a general sense, when policy shifts to a tightening stance through tapering of bond purchases and tightening of monetary policy, economic growth slows. This could pressure risk assets such as consumer cyclical equities in favor of more conservative sectors such as consumer defensive stocks and utilities.

There are signs that there may be a correction in the winds, but at this point there’s no saying to what extent or precisely when this is likely to materialize.

-Judd

Sources

Schwager, Michael. 21 June, 2021. Guggenheim Investments. “A ‘Hawkish’ Pivot Spooks the Market.” Retrieved from https://www.guggenheiminvestments.com/perspectives/weekly-viewpoint/a-hawkish-pivot-spooks-the-market