Ping An View:
The Federal Reserve announced that it would reduce its assets from US $95 billion a month to US $47.5 billion in three months after 2021. What is the difference between this fed scale reduction and the past? How has the impact on the market changed? This paper attempts to answer the above questions.
Reviewing the process of the last round of the Fed's table contraction, we can find that: 1) due to the lack of effective reference, the operation of the fed in the last round of table contraction is more cautious. The Fed is not in a hurry to reduce its balance sheet on a large scale, and the pace from guiding the tightening to table contraction is relatively slow; 2) In order to avoid cutting interest rates and shrinking the table at the same time, send different policy signals and alleviate the shortage of liquidity in the financial market, the Federal Reserve stopped shrinking the table in August 2019, two months ahead of schedule.
The macro background of the Fed's contraction is different, especially in terms of inflation. Compared with 2017, the current unemployment rate in the United States is lower, but inflation is higher. This determines that the purpose of the Fed's table contraction is different from that in the past, and the pace is relatively faster. We estimate that during the 22 months from October 2017 to August 2019, the size of the Fed's balance sheet decreased by about 15.7%. According to the Fed's table reduction plan, the Fed's balance sheet will decline by the same proportion in about 16-17 months (i.e. around October 2023). Looking back, the Fed may show greater flexibility in this reduction. On the one hand, the current employment situation in the United States is still relatively strong. If the inflationary pressure intensifies, the Federal Reserve may accelerate its pace of contraction, just as it accelerated taper in December 2021; On the other hand, considering that the interest rate increase and the table contraction have certain substitutability. If the inflationary pressure in the United States eases, in order to avoid a "hard landing" of the economy, the Federal Reserve may also slow down its pace of contraction.
At present, the structure of the Fed's balance sheet and policy instruments have undergone great changes, especially the reverse repurchase agreement on the liability side and the obvious increase in the scale and proportion of general deposits of the Ministry of finance, which may make the disturbance of the scale reduction on liquidity relatively low. First, from the asset side, the proportion of MBS with great uncertainty in scale change decreased, reducing the uncertainty of table reduction. Second, the sharp increase in the scale of reverse repurchase agreements and the short-term interest rate closer to the lower limit of interest rate mean that the market liquidity is more abundant than before the last round of table contraction, providing a thicker cushion for the liquidity impact of table contraction. Third, with the gradual normalization of U.S. fiscal policy, the general deposit scale of the Ministry of Finance may slowly fall back to the pre epidemic level in the second half of the year, so as to release certain liquidity to the market and alleviate the impact of table contraction. Fourth, the launch of the standing repo facility can provide liquidity under certain conditions, stabilize market confidence and reduce the probability of liquidity shortage.
It should be noted that although the market liquidity may not be greatly disturbed at the initial stage of the scale reduction, the impact of the Fed's scale reduction can still not be underestimated from the perspective of its impact on asset prices. Since the Federal Reserve's interest rate meeting in May, the 10-year US bond yield has risen to more than 3%, especially the real interest rate has returned from - 0.90% on March 1 to 0.34% on May 10, which reflects the impact of the market's further inclusion in the reduction. The rise of US bond interest rate has become an important catalyst for the adjustment of US stocks.
