FX.co ★ Fed's balance sheet policy threatens stocks

According to Business Insider, many investors expect the US Federal Reserve to shortly end its rate-hike cycle. However, the regulator's plan to shrink its balance sheet still poses a serious risk to the stock market.

This year, the Fed has so far trimmed down its balance sheet by $900 billion. Moreover, the regulator intends to stay the course. Such a policy move has an adverse impact on risky assets, analysts at Ned Davis Research believe.

Earlier, NDR experts noted in their study that monthly reductions in the Fed's balance sheet would deal a heavy blow to tech stocks and other risky assets.

Notably, the regulator has reduced its balance sheet to $7.6 trillion since June 2022. Later, however, it injected $400 billion of liquidity into the market to quell the US banking crisis. "Liquidity is the lifeblood of the financial markets... Risk assets love liquidity. Continued draining of liquidity presents a risk for equities and credit," Joseph Kalish, chief global macro strategist at Ned Davis Research, said.

According to Kalish, stock returns skyrocketed at a time when the Fed's reserves increased by more than $62 billion. A 31% annual increase in security returns was the highest since March 2009. There is also an inverse correlation. When the central bank's reserves fell by $38 billion, the stock market was in dire shape, the analyst added.