(Bloomberg) — The speculative darlings of the easy-money era — tech stocks and cryptocurrencies — are extremely vulnerable now that the Federal Reserve is shrinking its balance sheet by nearly $9 trillion.
Meanwhile, central bankers from Canada to Europe are poised to test the resilience of global markets as they follow hawkish US policymakers on a liquidity-sapping mission to unwind the buying spree. pandemic bonds.
That’s the broad outlook for Wall Street and beyond, according to the most popular responses from 687 contributors to the latest MLIV Pulse survey, as the Fed begins this month to trim its holdings in a process known as quantitative tightening.
The historic change is seen as a notable threat to tech stocks and digital tokens – two risk-sensitive assets that soared in Covid-era market mania before cratering in this year’s cross-asset crash. .
The era of ultra-cheap money seems over for now. The Fed’s balance sheet reduction is expected to last more than a year, while nearly two-thirds of survey respondents say the four-decade bull run in Treasuries is over.
It all comes against the risky backdrop of the Fed raising interest rates at the fastest pace in decades to tackle runaway inflation, as officials seek to quash talks of a September pause. .
Recent swings in stocks, bonds and other markets have done little to deter the US central bank from its hawkish stance, with policymakers expecting them to hike rates another half point on 15 June. The Fed began shrinking its balance sheet this month by allowing assets to mature without reinvestment at a monthly rate of $47.5 billion, rising to $95 billion per month in September.
“It’s where that amount of capital and that amount of liquidity has been most beneficial that its withdrawal is going to continue to be felt – and that’s in the most speculative parts of the market,” said Lisa Shalett, director investments at Morgan Stanley Wealth. Management, said on Bloomberg Television.
The MLIV survey of riskiest assets in the QT era surveyed a group ranging from retail investors to market strategists. Just 7% chose mortgage-backed bonds – securities that were at the heart of the 2008-09 meltdown – with almost half citing technology and crypto.
Draining money from the system tends to tighten financial conditions, all other things being equal, which acts as a drag on economic growth. This can reduce the valuations of technology stocks given their reliance on optimism about future earnings.
The Fed’s end to bond purchases also forces the Treasury to sell more debt in the open market, which could put upward pressure on bond yields, which play an important role in how Wall Street values. publicly traded companies – a headwind for so-called growth stocks in particular.
Fueled by pandemic-era policy easing, the tech-heavy Nasdaq 100 index soared more than 130% from its March 2020 low before plunging this year.
Meanwhile, cryptocurrencies have increasingly been driven by swings in tech stocks. Since March 2020, there has been a strong positive correlation between Bitcoin and the Nasdaq 100, with the relationship intensifying during this year’s selloff.
The idea is that when silver is cheap, traders can massively speculate on future digital trends. But when the liquidity party wears off, those bets get more expensive.
“I don’t think people fully realize how QE has caused investors to add a lot of leverage to their positions,” said Matt Maley, chief market strategist for Miller Tabak + Co. “Now as we go through QT, this leverage has to be unwound.
Respondents who were active in the market during the financial crisis more than a decade ago are particularly concerned that the reduction in the Fed’s balance sheet will hurt junk bonds. New entrants are more likely to worry about its impact on crypto and tech shares.
Readers are sounding the alarm bells more widely about global business conditions as the likes of the European Central Bank – which meets this week – and the Bank of England seek to rein in their expanded balance sheets. Nearly 53% said they fear markets are underestimating the importance of central bank liquidity outside the United States.
Only 8% described QT in general as overestimated. Yet the primary concern for MLIV readers remains how much the US central bank will raise benchmark borrowing costs over this cycle. Some 61% said the level at which the terminal federal funds rate peaks is more important than the amount by which the balance sheet contracts.
When it comes to QT’s endgame, around two-thirds say the main catalyst is more likely to emerge from negative developments than from a win on the inflation front. Some 38% said economic difficulties would lead to an end to the balance sheet meltdown, while 20% pointed to market turmoil.
Only 10% voted for issues related to bank reserves and short-term funding markets. It’s an implicit vote of confidence in the steps the Fed has taken to avoid the bottlenecks in the financial plumbing that led it to intervene in 2019 during its previous tightening program.
For many, the era of ultra-low rates and big central bank balance sheets is all they have known professionally. Some 46% of MLIV respondents were not active in the markets before the widespread global adoption of quantitative easing in the aftermath of 2008.
Fewer still have surfed the first long-term Treasury bull market in recent decades. A strong majority of readers – 64% – say the four-decade bull run is finally over, with experienced market participants significantly more hawkish than their younger counterparts.
“Anytime you see major changes in liquidity, you may see disruptions in the market and that could trigger violent trading behavior,” said Ed Moya, senior market analyst at Oanda.
- For more market analysis, see the MLIV blog. For previous surveys and to subscribe, see NI MLIVPULSE.
©2022 Bloomberg LP