BofA Says Quantitative Tightening Would Shave 7% Off S&P 500
If history is any guide, the winding down of the central bank’s balance sheet poses a risk to equity prices, says BofA.
(Bloomberg) -- Stocks are already facing numerous headwinds stemming from the Federal Reserve’s aggressive interest-rate hikes. But if history is any guide, the winding down of the central bank’s balance sheet poses a risk to equity prices, according to Bank of America.
When looking at the historical relationship between the Fed’s bond purchases and S&P 500 returns from 2010 to 2019, the bank concluded in a research note on Monday that quantitative tightening through 2023 would translate into a 7% drop in the benchmark gauge from current levels. According to BofA, quantitative easing has explained more than 50% of the movement in the market.
Quantitative tightening has undoubtedly taken a back seat to more pressing issues such as inflation and recession angst, Chris Zaccarelli, chief investment officer at Independent Advisor Alliance, said. Yet, the tapering of the Fed’s asset holdings may come to the forefront as growth continues to slow.
Read more: What the Fed’s ‘Quantitative Tightening’ Plans Mean: QuickTake
“The market has been celebrating the fact that the next rate increase is likely going to be 50 basis points and not 75, and yet the market does not seem to be looking ahead to QT,” said Jane Edmondson, founder of EQM Capital. “I think the assumption is that -- given how well telegraphed the Fed’s QT plans have been -- it is already priced into the market.”
The Fed started winding down its $8.9 trillion balance sheet in June and is phasing in the reductions to an eventual pace of $1.1 trillion a year. In the two months since, the S&P 500 has gained 4.8%.
Read more: How Fed ‘QT’ Intersects With $2 Trillion in Cash: QuickTake
“If financial conditions tighten in a meaningful way, then that could make QT a more important topic,” said Zaccarelli. “I imagine it is very difficult to have a high degree of certainty about the stock market impact of QT and that I would be much more focused on S&P earnings and much less focused on S&P P/E multiples.”
A new study by a Federal Reserve Bank of Atlanta economist found that asset reductions will have a relatively modest impact on the economy compared to the Fed’s raising of interest rates to fight inflation, equating the effect over time to no more than three quarter-point interest-rate hikes.
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