The end of the easy money era is fast approaching
Market participants now expect the Fed to scale back its asset purchases faster, possibly doubling the decline to $ 30 billion per month. That would see the $ 5,000 billion program end in March, paving the way for the first U.S. interest rate hike since 2018.
Earlier this year, according to projections by the Fed’s Open Market committee (which sets US monetary policy), most of its members expected the first interest rate hike to take place in 2023. Now, the bond market is anticipating up to three increases of 25 basis points over the next year.
The period since the 2008 crisis has been marked by debauchery by central banks, with ultra-low interest rates and huge injections of liquidity into financial systems.
The US yield curve actually suggests that the Fed changed course too late. The yield curve is as flat as it has been for almost two years, with the spreads between five- and 30-year T-bills and two- and ten-year securities narrowing considerably towards the end of this period. year.
Indeed, it signals the belief that the Fed will be forced to act aggressively to stifle inflation and in so doing stifle growth and risk a recession with higher interest rates than it does. ‘had considered or probably considering today.
The bond market could be wrong. The wild cards are supply chain issues, which could be resolved faster than expected, and the pandemic.
Each mutation of the virus causes tremors in financial markets, but the latest variant, Omicron, while apparently highly contagious, also appears to be less virulent than previous mutations. The markets effectively dismissed it as a threat to the economy, with the US S&P 500 index setting a new record on Friday.
However, if the bond market is broadly correct and the Fed (because its realization that inflation might not be transient was late) is forced to raise US rates faster and further than it needs to be. wish, a significant rise in interest rates would pose a real threat to asset prices, especially stocks and house prices, where values have swelled significantly during the pandemic.
There has been a fairly dramatic build-up in debt over the past two years, particularly (but not exclusively) government debt levels. Households and businesses have also benefited from historically low interest rates and the plentiful supply of cheap credit.
This means that an acceleration in the pace of monetary policy tightening in the United States will have more immediate and unpleasant effects than it might have had in the past. It also means that the Fed will feel limited to some extent by the potential consequences of going too hard, too fast. He faces extremely difficult and delicate decisions.
Whatever the Fed does, it will have global implications due to the dominance of the US dollar in the financial, debt and currency markets.
The period since the 2008 financial crisis has been marked by debauchery by central banks, with ultra-low interest rates and huge and continuous injections of liquidity into the financial systems of developed economies.
If the Fed exits the US bond and mortgage markets by March of next year and US rates are on a sustained upward path by mid-year, it could mark the end of an era. easy money and distorted pricing of risk; an era marked by the financial crisis and the pandemic.
In the long run, that wouldn’t be a bad thing – unconventional central bank policies post-GFC have had unwanted effects on wealth inequalities and the allocation and pricing of capital – but it could have consequences for the future. short term quite traumatic.