The wild card that could sink stocks: What investors need to know as the Fed unwinds liquidity that had helped fuel market gains

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This 'wild card' is making some market watchers nervous. Here's why.

Quantitative monetary easing is credited for juicing stock market returns and boosting other speculative asset values by flooding markets with liquidity as the Federal Reserve snapped up trillions of dollars in bonds during both the 2008 financial crisis and the 2020 coronavirus pandemic in particular. Investors and policy makers may be underestimating what happens as the tide goes out.

Since 2010, QE has explained about 50% of the movement in market price-to-earnings multiples, said Savita Subramanian, equity and quant strategist at Bank of America, in an Aug. 15 research note . The unwinding of the Fed’s balance sheet that began in 2017 after the economy had long recovered from the 2008-2009 crisis was supposed to be as exciting as “watching paint dry,” then-Federal Reserve Chairwoman Janet Yellen said at the time. It was a ho-hum affair until the fall of 2019, when the Fed had to inject cash into malfunctioning money markets. QE then resumed in 2020 in response to the COVID-19 pandemic.

The slow pace of the wind-down so far and the composition of the balance-sheet reduction have muted the effect of QT so far, but that’s set to change, Garrib said.

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The wild card that could sink stocks: What investors need to know about the Fed's accelerating QTQuantitative easing is credited for juicing stock-market returns. Investors may be underestimating the fallout from accelerating quantitative tightening.
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