Between the tightening of the Fed's balance sheet (Quantitative Tightening) and the term "anxiety", derived from the Latin angustia (narrow or tightening), let us hope that the link remains only etymological. The will shown by the members of the Fed, during the last minutes of the FOMC, to begin the reduction of the balance sheet of the central bank quickly after the first increase in key rates is indeed, in our opinion, a real change of paradigm (which can cause fear) in anticipation of the level of US long rates. This measure has a much greater impact on the long end of the yield curve than tapering or the increase in key rates, which have a greater impact on short rates and flatten the yield curve.
The Fed is therefore preparing to do in 6 months what it took 4 years to do during the last phase of monetary normalization (from the end of 2013, the start of tapering, to the end of 2018, the start of balance sheet reduction), even if the situation is, of course, different if only at the level of the fight against inflation. If Jerome Powell, during his hearing before the Senate, returned to a more accommodating tone than the last minutes of the FOMC suggested, the exit of several members of regional Feds in the same week leaves little doubt on the strength of the coming tightening. James Bullard, President of the Saint Louis Fed, considers that there will “perhaps be a need for up to four hikes in 2022”, while campaigning for a reduction in the Fed's balance sheet from the spring. Ditto for Loretta Mester, President of the Cleveland Fed, who considers that the start of Quantitative Tightening must start “as quickly as possible”. The Fed should therefore quickly move from discussion to action on reducing the size of its balance sheet, which now exceeds 35% of US GDP (compared to less than 20% before the crisis). This reduction should even be faster than in the previous phases. Raphael Bostic, President of the Atlanta Fed (but non-voting member of the FOMC), considers, for example, a more "aggressive" response from the Fed to fight inflation with a reduction in the size of the bank's balance sheet. central of at least $100 billion a month to quickly purge $1.5 trillion of excess liquidity.
The publication, last week, of several macroeconomic figures across the Atlantic came to reinforce the statements of the most hawkish members. Inflation for the month of December thus increased, once again, by 0.6%, which brings the rise over one year to +7%, in line with expectations. The University of Michigan confidence index almost came out at 10-year lows with inflation expected by Americans over the long term at the 2011 highs (see chart of the week).
The Fed will therefore have to succeed in normalizing inflation while preserving growth, which is facing in the short term the resurgence of the epidemic (via the Omicron variant) and supply issues as evidenced by the cuts in production of industrial and retail sales for the month of December. Once again, the tightrope walk promises to be difficult, especially when the tightrope walker is asked to pick up the pace...
