New Year, New Fed

Weekly Market Update | January 10, 2022

Highlights

The prospect for tighter central bank monetary policy caused global equities (as measured by the MSCI AC World index) to finished the week 1.5% lower. U.S. technology stocks were hit particularly hard with the interest rate sensitive NASDAQ shedding 4.5%. Cyclical stocks performed better with the Dow Jones losing just 0.3%. International stocks performed slightly better, but still closed the week lower. The 10-year U.S. Treasury yield surged 25 basis points from 1.51% to 1.76% by week-end.

Monetary policy uncertainty has risen over the past few weeks with the Federal Reserve surprising investors with their hawkish pivot. The latest surprise came from the minutes of the Fed’s December Federal Open Market Committee (FOMC) meeting when it reported that many participants believed it would likely be appropriate to initiate balance sheet runoff at some point after the first rate hike. The key takeaway being that the Fed may no longer substitute balance sheet reduction for a quarterly rate hike.

If the Fed allows runoff of the balance sheet while also raising rates, it would be using two separate tools to tighten policy at the same time. That could result in tighter financial conditions than if the Fed was simply raising rates, which is why long-term yields have shot up and technology shares have slumped. The market is now pricing in a first hike in March 2022.