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Stock and bond markets are falling sharply as an influential executive of the US central bank (Fed) warns of an aggressive tightening of monetary policy.
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Lael Brainard is driving long-term interest rates higher worldwide, because she signals that the Fed may already shrink its balance sheet significantly from May. The European stock markets are reacting very negatively. The Euro Stoxx50 fell by more than 2 percent on Wednesday. Tech stocks like Adyen
Prosus
and Infineon
get hit hard because they are interest rate sensitive. The technology sector (-3.7%) is the biggest decliner in Europe, followed by automakers (-3.6%) and travel stocks (-3.2%). The Bel20
falls more than 2 percent.
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Long-term interest rates, which already skyrocketed yesterday, continue to rise. Belgian interest rates are above 1.2 percent for the first time since 2015. In the US, the 10-year yield has risen to 2.63 percent.
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As the economic recovery is much stronger than in the previous cycle, I expect the balance sheet to contract significantly faster.
Lael Brainard
Manager Fed
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“It is of the utmost importance to reduce inflation,” Brainard emphasized in a speech. We will continue to methodically tighten monetary policy through a series of rate hikes and perhaps starting a rapid balance sheet contraction as early as May. As the economic recovery is much stronger than in the previous cycle, I expect the balance sheet to contract significantly faster than during the previous cycle.’
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pigeon
Brainard’s stern message is remarkable. She is often regarded as a dove, a central banker with a strong focus on growth and in favor of relatively accommodative monetary policy. Brainard is influential because President Joe Biden nominated her as vice chairman of the Fed. Other Fed executives have also expressed concern about rapid price increases in recent days. Inflation according to the Fed’s preferred measure is 6.4 percent, more than three times the target of 2 percent.
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The Fed plans to shrink its balance sheet by not reinvesting yields from maturing government bonds and repackaged mortgages in new paper. The previous balance sheet contraction occurred between September 2017 and September 2019. Then the balance sheet total fell by $700 billion to $3,760 billion.
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pandemic
But since then, the balance has grown spectacularly again. Since the start of the corona pandemic, the Fed has been buying bonds en masse to lower long-term interest rates and give the economy more oxygen. As a result, the balance sheet grew by $ 4,780 billion to 8,940 billion.
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The money market expects the Fed to raise interest rates by 250 basis points this year. That would be the largest rate hike since 1994.
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Brainard’s speech has also fueled speculation about a faster rate hike. The money market now expects the Fed to raise interest rates by 225 instead of 200 basis points later this year. Together with the interest rate hike of 25 basis points in March, the key interest rate is expected to rise by 250 basis points this year. That is the biggest interest rate climb since 1994. For an even bigger rate hike, we have to go back to the early 1980s.
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The European Central Bank (ECB) is more cautious than the Fed. It will continue to increase its balance sheet through additional bond purchases through June and will not stop those purchases until the third quarter. The money market expects the key ECB interest rate to rise by only 50 basis points this year. Core inflation in the eurozone is much lower than in the US, partly because the fiscal stimulus was smaller during the pandemic.
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