Here’s what happened the last time the Fed attempted to shrink its balance sheet and hike rates simultaneously

Here’s what happened the last time the Fed attempted to shrink its balance and hike rates simultaneously…

Chart via Peter Boockvar, a throwback to 2018:

It was a disaster. That white line you see if the Fed allowing bonds to “run off” or mature without replacing them with more bonds. This is a shrinking of its balance sheet or what has been termed by others as Quantitative Tightening (QT).

Two separate major corrections occurred that year, culminating with a nasty 20% crash into Christmas Eve which finally forced the Fed to say “Okay, just kidding. Not only are we not raising rates anymore, actually, the next few moves will be cuts. Merry Christmas, we’re sorry.” I’m paraphrasing, but that’s literally what happened. The Fed had gotten up to 2.5% Fed Funds (orange line) and both the stock and bond market called “Bullshit!” on them – meaning, the economic growth story was no longer being bought. By Q3 2019 the yield curve had inverted and in 2020 we were maybe on track for a recession, with or without Covid.

You forget how f***ed up and counterproductive the stupid trade war with China was and the real economic damage of all those tariffs. Pre-Covid, Trump was bailing out his beloved farmers and steelworkers left and right because of his own misguided nonsense policies. I bumped into White House Chief Economic Advisor Larry Kudlow in an NBC greenroom that year – even he couldn’t defend this shit off-camera.

Anyway, putting the balance sheet into run-off while concurrently hiking rates at every meeting was a bad idea in that environment. Not only did it not help the Fed achieve its dual mandate of full employment / stable prices, it actually worked against everyone’s interests. Which is why that hiking cycle had to be unraveled just a few months later.

And now, four years later, there are people who want to tell you that the Fed is anxious to repeat this experiment? Lift-off in rates while simultaneously shrinking its balance sheet and tightening financial conditions, upending stocks and bonds while it seeks to normalize policy. With Omicron running circles around the CDC and local governments? Yeah, okay. That’s a dumb f***ing bet. Powell is smart.

If you got spooked by the Fed Minutes this week, where one or two members were sort of maybe discussing the possibility of run off, it’s understandable. A lot of very serious, very (self-) important people were doing TV hits actually taking this scenario seriously. Don’t.

The reality is that these bond buying programs should have been tapered this past summer and fall as home prices and stock prices and retail sales were exploding higher. Many of us had been shouting this from the rooftops. The sooner they stop stimulating the market, the better. But they’re not looking to go so fast as to repeat the mistakes of 2018. Why would they? Where is the gun to their heads?

I’ll give Peter the last word here:

Is it even worth having the discussion now about a shrinkage in the Fed’s balance sheet while they are still growing it into March? No. The minutes said ‘some’ talked about this, not ‘several.’ Is the Fed going to repeat 2018 when they were hiking rates and letting the balance sheet run off at the same time? Doubtful.

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here:

Please see disclosures here.