Fed aims to shrink the balance sheet: How to invest?
Fed officers have come under the spotlight once again with an unyielding determination to put inflation in check, stating it's of paramount importance to ensure the stability of goods prices. When investors keep pondering over the possible number of rounds of rate hikes, the Fed, however, is contemplating another vehicle to cool off the economy: the shrinkage of the balance sheet.
Selling bonds to pare down the balance sheet
As we're familiar with, QE refers to a series of open market operations such as buying bond securities from investors by the Fed so that more money will be infiltrated into the economy. In this way, the Fed is expanding its balance sheet with securities listed in the asset column and cash treated as liabilities.
Conversely, when the economy is overheating and inflation appears concerning, the Fed will start tapering, which means slowing down the pace of purchasing bond securities, and even implementing quantitative tightening policies when things tend to be out of control.
Then the Fed will dash into the open market to sell bond securities to dampen the prices of bonds and bolster long-term interest rates in the meantime. Consequently, money will flow back to the Fed from the market resulting in the reduction of its balance sheet. The economy will also be expected to cool off along with the reduction of the money supply and the increased costs of financing.
The chart above shows the chronology of the Fed balance sheet, it seems that the Fed keeps adding to its assets since the financial crisis in 2008, and there's a moderate QT period starting in late 2017, and then the Fed began to purchase securities at an astonishing speed to offset the economic lockdown incurred by the pandemic.
Fed's assets still remain at a high level, yet the growth speed starts to drop as the asset curve tends to plateau in the near future. It's a crucial signal for investors since the Fed is taking its foot off the gas.
Repos and reverse repos are magical tools
Fully known as repurchase agreements and reverse repurchase agreements respectively, repos and reverse repos are another two common ways for Fed to interfere with the market. A repo is a procedure of selling short-term securities to one partner and purchasing them back at a future date. A reverse repo is the exact opposite.
Thus repos have the effect of constraining capital liquidity while reverse repos can inject money into the market.
As we can see above, reverse repos have jumped into the stratosphere as the Fed was eager to rejuvenate the economy. However, no more reverse repos have been created for a while. Investors should watch out for a sharp decline in reverse repos as the Fed is contemplating retrieving capital from the open market.
Fed assets can drive the S&P 500 up
This should be no surprise since the Fed will provide an influx of money into the economy when it starts to expand the balance sheet. The economy will recover and boom as well as the stock market, represented by the S&P 500 index.
Which sector performs the best during the previous QT?
The previous QT starts in early 2018 and ends in September 2019. While the overall index performed resiliently and rallied back despite two sell-offs, we want to get more sector-oriented insights to guide our investments. Depicted below are eight ETFs representing eight sectors.
Among those eight charts, four ETFs inched higher during the tightening period. Especially, XLU and XLRE stand out predominantly without serious drawdowns and with significant capital gains. They represent the utilities and the real estate sectors, respectively, notching nearly 35.5% and 33% upsurges. $Utilities Select Sector SPDR Fund (XLU.US)$ $Real Estate Select Sector Spdr Fund (The) (XLRE.US)$
Conclusion
As of late, Fed's balance sheet has shown signs of cresting along with the number of reverse repurchase agreements. The stock market can usually weather the storm during a tightening cycle, as history has told us, and investors should pay attention to the utilities and the real estate sector since they show decent records through the previous reduction of the Fed balance sheet.
Disclaimer: Investing involves risk and the potential to lose principal. Past performance does not guarantee future results. This is for information and illustrative purposes only. It should not be relied on as advice or recommendations.
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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搞经济 抄底 加仓 : Goes the opposite way. whenever they say how safe it's gonna be. Pack and start RUNNING.
️ All.In![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")
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Trust me &%£+×¥₩
But whenever they say how bad things gonna be. Buy the Dip , Show hand
*Still research are needed. Do not trade blindly*
^Remember FED and those in the WStreet are not a friend of yours. They didn't create Stock market for you to take gains
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Eng Hock : very true, lots of conspiracies among big fishes.
102711703 : Don’t understand this article. Can someone make it more simple to understand?
chenhaoyang 102711703 : Keep your hands in check and don't move forward
omgupup 搞经济 抄底 加仓 : ji