Investors around the globe are watching The Federal Reserve to see how it will unwind its massive balance sheet. Since the financial crisis, the Fed (and other global central banks) grew its balance sheet by adding trillions of dollars of liquidity to the financial system (The Fed's latest balance sheet is available here). Now, investors are asking one important question: Will the Fed by able to unwind its balance sheet gracefully? Only time will tell what they actually do and how the market will react. At this point, there is real concern on Wall Street that the market may sell off hard if the Fed is not able to unwind its massive balance sheet gracefully.
What The Pros Are Saying:
I always like asking the pros to get an objective/outside opinion. Here are some thoughts about this week's Fed meeting and how the Fed will unwind its balance sheet:
Todd Crescenzo, Chief Investment Officer, Investment Placement Group
For this week’s meeting we would expect that FED to take no action on rates, holding Fed Funds at the previous range of 1% (lower bound) to 1.25% (upper bound). We do suspect the Fed will formalize its balance sheet reduction program, but the size and scope will be the important for the market to pay attention to. What is more important for the market will be how the Fed’s communique addresses the recent further easing of financial conditions (continuously higher equity prices, tighter credit spreads). They will look to balance the longer term financial conditions via its forward guidance – the infamous “dot plots” and this meeting’s economic forecast update. They will also likely address financial markets’ valuations in their communique as another method to jawbone markets.
Larry Milstein, Senior Managing Director, R. W. Pressprich & Co.
I do not believe that the Fed will raise rates on Wednesday although it is very likely that we will get further detail on the feds plan to unwind its balance sheet. Moreover, I suspect the balance sheet reduction Will begin in short order. We will, however, see the release of the feds DOT plot, which illustrates fed members expectations for rates going forward, and I believe the DOT plot will show that the majority of Fed members anticipate another hike in December. These adjustments by the Fed should lead to a flatter yield curve and generally higher rates over time.
Steve Merdinger a Member at Private Vista LLC
The markets are not expecting an interest rate increase now, so there would probably be a negative reaction if they are surprised with an increase. An increase right now would be negative for the yield curve, which has been flattening this year. A flatter yield curve is negative for the equity markets because it reduces the incentive for lending.
H. Edward Shill, CFA President and CEO, QCI
The QCI outlook is that the equity market is fully discounting a ¼ point hike in the Fed Funds rate in Dec of 2017. More importantly the Fed Balance sheet “trimming” needs to be watched even closer. If the stock market has been jacked up by QE since 2009 then the “unwind” of QE has to watched and to some extent feared. The old adage of “ Don’t fight the Fed” is a manta one is often inflicted pain upon if not adhered too”
Alex Bernier, Jr. Equity Analyst, QCI Asset Management
We expect to see the market react similarly to the last hike. At this point we would figure that the market has taken some certainty in Yellen’s plan on this 25 basis point run up each hike through 2018. We would anticipate that the market being relatively muted coming into the meeting implies that expectations have somewhat been factored into current sentiment.
Nicholas Perini, Portfolio Manager & Vice President at Besse Fulmer
As long as the interest rate hikes remain gradual, I believe the stock market can continue to flourish. The current environment is similar to the period in the early 1950’s when interest rates were rising gradually from a low base and the stock market did very well. Assuming the Fed doesn’t become too aggressive, the stock market could react in the same way it did back then - and that would be a good thing for equity investors.
Colleen Kelleher Sorrentino, Wall Street Access Asset Management
So if the Fed raises rates, we think it will only be ¼ %. The increase will probably not move the market, as the increase is already priced into the market. Although, we think there is a great chance that the Fed will not increase at all. This is due to the hurricane which probably will have a big effect on the GDP.
David Gilreath, Chief Investment Officer, Sheaff Brock Investment Advisors, LLC
If the Fed raises rates (which they likely won’t near term due to the flattish yield curve) it would help the stock market. The Fed would be signaling that the economy is continuing to strengthen. That, combined with the weak dollar would help drive corporate earnings higher, perhaps more earnings upside surprises and benefiting equity prices.
As you can see, the jury is out and that is exactly what makes a market.
The Fed knows that it has to walk a very thin line with respect to unwinding its massive balance sheet. Only time will tell
A. What the Fed will actually do to unwind its balance shee
B. Then, we have to see how capital markets react.
It's never a dull moment on Wall Street.