The Fed's sudden change of hawkish style caught the market off guard, and now the market is holding the idea of "if you can't fight, join" and have issued more hawkish shouts.
Compared with Powell's hint that the balance sheet will begin later this year, the agency has advanced this time by nearly half a year.
In a research report published jan. 14, Bank of America said it believed the Fed would announce the start of a balance sheet reduction at the FOMC meeting on June 22 this year, and did not rule out starting in May, compared with their previous forecast in September.
Bank of America mentioned that the reason why they expected the start of the balance sheet reduction to be advanced was affected by the speeches of Fed officials.
Earlier, The Fed's dovish official, San Francisco Fed President Mary Daly, revealed that the Fed could "adjust its balance sheet after one or two rate hikes."
So suppose the Fed starts raising interest rates in March this year, which means that after the details of the key balance sheet reduction plan have been determined, the balance sheet reduction will be announced in the late spring or summer.
Not only "earlier", but also "faster"
Previously, Bank of America expected the Fed to scale back $70 billion a month, including $40 billion in Treasuries and $30 billion in mortgage-backed bonds (MBS), and now they have raised that expectation to $100 billion per month, which includes $60 billion in Treasuries and $40 billion in MBS.
Bank of America believes that this estimate is also in line with the tone of the December FOMC meeting, that is, this round of balance sheet reduction is faster than the previous round (the last time was a $30 billion monthly reduction in Treasury bonds and $20 billion MBS), and Atlanta Fed President Boston also supported "at least $100 billion per month balance sheet reduction.".
And if the scale-down plan is carried out at this rate, the target scale may be achieved much earlier. The Fed's asset holdings are expected to shrink to $5.4 trillion by June 2025, down $3.6 trillion from its peak in March 2022.
In addition, Deutsche Bank similarly put forward a hawkish view in its January 16 report, arguing that there are several factors that could lead the Fed to tighten in the coming months:
- The ECI (Employment Cost Index) hit another ten-year high, the largest single expense faced by companies;
- The month-on-month inflation data shows no signs of easing;
- The labor market continued to maintain strong momentum, rapidly reducing the unemployment rate to historical lows.
"Unexpected Events"
At the same time, however, Deutsche Bank has made some different points of view, arguing that the occurrence of certain "unexpected events" may also slow the fed's tightening rhythm.
The first is that high inflation due to supply problems may "naturally ease".
They analyzed the core PCE price index and believed that two-thirds of the inflation increase was triggered by the supply side, so if the supply shortage can be alleviated, then the level of inflation may fall with it.
Considering that the Fed can only adjust the inflation caused by the demand side at most, it does not have much room to play on this issue itself, and it is too aggressive to help.
In addition, lower long-end yields on U.S. Treasuries are also a signal. While this is partly due to the Fed's large purchases of bonds, it also reflects the long-term low inflation expectations in the United States (long-term yields on U.S. Treasuries = inflation expectations + real economic growth rates).
So in this situation, Deutsche Bank believes that a relatively flat tightening cycle is enough to put inflation back on track, and this restrained "soft landing" will also avoid impacts on financial markets.
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