(Yahoo!Finance) - Along with being expected to start a rate hike cycle in March, the U.S. Federal Reserve is expected to stop purchasing assets to add to its $9 trillion balance sheet.
And while multiple rate hikes seems to be largely factored into the stock market, winding down the balance sheet — i.e., start selling assets into the market as opposed to buying — is a less understood variable.
“When... the most reliable buyer with its own printing press and an incredible willingness to buy – when they step out of the market, that is a fundamental change to the marketplace,” Mohamed El-Erian, president of Queen’s College at Cambridge University and Chief Economic Advisor at Allianz, told Yahoo Finance Live this week (video above). "So it shouldn't come as a surprise that [stock prices] are lower, because $120 billion a month of asset purchases are disappearing."
El-Erian stressed that unwinding the balance sheet "need not be disorderly. If you can establish and you still have strong fundamentals, people will come in and take the leg up based on something much more lasting than a liquidity regime. The concern we have is by being late, the Fed also puts economic growth in play. And that means earnings become more uncertain. So that's why this is a very delicate period. There is still a window to get this right. But unfortunately, that window is closing."
A tightening cycle that is unlike any we have seen in the past'
The anticipation of increased Fed hawkishness is one of the reasons behind the uptick in volatility this year, with the CBOE Volatility Index averaging more than 23 thus far in 2022 after average of just under 20 in 2021. The MOVE Index, which measures Treasury market volatility, has also seen a more dramatic surge with a 19 percentage point rise so far this year.
According to Liz Ann Sonders, chief investment strategist at Charles Schwab, investors have to try to factor in the shrinking of the balance sheet – what she called “a tightening cycle that is unlike any we have seen in the past” – even if it’s uniquely challenging to do so.
Julie Hyman · Anchor
