The Federal Reserve’s efforts to take some steam out of an overheating U.S. economy by draining liquidity from the financial system may be having the opposite of their intended effect, according to Bank of America interest-rate strategist Ralph Axel.
This could potentially explain the boost that U.S. stocks have received this year, as the S&P 500 SPX has risen roughly 15% since the beginning of 2023, according to FactSet data. Although these gains have yet to offset a 19.4% drop from 2022, the worst calendar-year performance for the index since 2008.
In September, the Fed accelerated the pace of its balance-sheet unwind to $95 billion a month, with maturing Treasury bonds representing roughly two-thirds of that figure. “The key observation here is that the public spends one form of government liability to buy another. It is an asset swap. As a result, the liquidity drain doesn’t actually reduce financial assets of the public, it only changes the composition of financial assets held by the public,” he said in a note to clients shared with MarketWatch on Thursday.