Major reversals on Wall Street as monetary policy tightens

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The move by the US Federal Reserve and other central banks to tighten monetary policies and suppress workers’ wage demands in the face of soaring inflation is producing wild swings on Wall Street and raising major issues in financial markets in the states. United and around the world. .

Traders work on the floor of the New York Stock Exchange. (AP Photo/Richard Drew)

On Wednesday, following the Fed’s decision to raise its base interest rate by 0.5 percentage points (50 basis points) and Chairman Jerome Powell’s remark that the central bank was “not actively considering “a rise of 75 basis points, Wall Street jumped.

But the so-called rally lasted less than a day. On Thursday, the market reversed all of those gains and more, undertaking the biggest turnaround since the pandemic began in early 2020.

The Dow fell more than 1,000 points, 3.1%, to register its biggest drop this year after posting its biggest rise since 2020 the day before. The S&P 500 fell 3.6%. The biggest drop was on the tech-heavy NASDAQ, the most sensitive to interest rate hikes.

It fell 5% to post its biggest one-day percentage loss since June 2020, taking its total loss from its record high of November last year to 24%.

Thursday’s selloff, which continued yesterday with smaller but significant losses, was a resumption of a year-to-date trend that has seen more than $8 trillion wipe out the market value of stocks.

There was also another sell-off in the bond market which pushed the yield on the 10-year Treasury note to over 3%, its highest level since November 2018, with the rise continuing yesterday. (When bonds are sold and their price falls, the interest rate or yield rises.)

In addition to raising the interest rate by 50 basis points, Powell said there was a “sense” on the decision-making body that “additional 50 basis point hikes should be on the table at the next two meetings, the Fed has also decided to start trimming its $9 trillion in financial assets, which include Treasuries and mortgage-backed securities.

The Fed will begin to reduce its holdings of these assets by $47.5 billion for each of the three months, starting in June, and then by $90 billion per month in September.

While media coverage has focused on the rate hikes, the view of some analysts and commentators is that the balance sheet reduction is more important. It has never been undertaken before except for a brief period in 2018, when it was quickly reversed after a backlash on Wall Street late that year.

Fed assets, which stood at less than $1 trillion in 2008, increased ninefold due to the quantitative easing initiated after the global financial crisis and the additional injection of about $4,000 billions of dollars in the financial system following the March 2020 crisis at the start of the pandemic.

No one in the financial world, at the Fed and certainly not Powell has any real idea what the consequences might be.

Asked at his press conference on Wednesday what effect the reduction in the balance sheet might have on monetary policy, Powell replied: “In terms of effect… I would just like to point out how uncertain the effect is of the reduction of the balance sheet. You know, we run these models and everyone does that in this area and makes estimates… And you know, those are very uncertain. I really can’t be any clearer… We don’t really know.

It’s a telling admission, shattering the myth that the Fed, with its vast array of computer information and analysis, is, if not entirely in control, at least has some idea of ​​where it’s headed. But after triggering one of the most sweeping monetary policy shifts in history – the pouring of trillions of dollars into Wall Street to prevent a meltdown in the financial system – he has no idea what any reversal might produce. .

However, others have issued a warning. This week the Economist noted that the Fed is now the largest holder of US government debt with $5.8 trillion of Treasuries on its books, a quarter of the $23 trillion total. It also holds $2.7 trillion in mortgage-backed securities.

According to the article, reversing this “portfolio juggernaut” through quantitative tightening “could trigger a repeat of the temporary but troubling breakdowns that the world’s most important financial market has suffered in recent years, on a larger scale.”

It was possible that “QT [quantative tightening] will cause the Treasury to malfunction” and that its “proper functioning matters way beyond America” because Treasury rates “are a crucial benchmark for pricing virtually every other financial asset in the world.”

Recent history, he said, was not encouraging, recalling the crisis in the repo market, where treasury bills can be exchanged for cash in short-term transactions, in September 2019, and the March 2020 COVID shock when the Treasury market stopped working for several days. No buyer could be found for US debt, supposedly the safest financial asset in the world.

These crises were “temporary,” but only because the Fed stepped in massively, becoming the backstop for the Treasury market and virtually every other sector of the financial system. The crisis was averted but, as various reports have made clear, the underlying issues that led to it have not been resolved.

the Economist noted that the conditions for a new crisis are developing because there is a “decline” in liquidity in the Treasury market. It refers to a situation in which trades can have an outsized effect on the market as a whole, as opposed to a situation of abundant liquidity in which their effect is small.

Highlighting this situation, the article said there was “the growing possibility of a new malfunction” that would make it “more likely for the market to crash.”

If that happened, the Fed would have to step in with massive support, as it has done in the past, but this time under conditions not of low inflation, but of inflation spiraling out of control.

The shift to higher interest rates is beginning to impact all sectors of the financial system and the broader economy in the United States and around the world. Even before the Fed’s latest move, interest rates were rising across a range of U.S. markets, from home loans to auto loans.

the FinancialTimes reported that the value of junk U.S. junk bonds trading at 70 cents on the dollar – a level seen as a sign of distress – rose to $27 billion from about $14 billion at the time. end of last year.

In Europe, even though the European Central Bank (ECB) has not raised its interest rate, borrowing costs are starting to rise and investors are demanding higher interest rates when lending to the most indebtedness of the euro zone.

This raises the prospect of a divergence between northern and southern European countries that led to the crisis that threatened the continuation of the euro in 2012. This was only averted when ECB President Mario Draghi said the central bank will do “whatever it takes. But inflation, coupled with the turmoil resulting from the war in Ukraine, has dramatically changed the situation from a decade ago.

In all major economies, the central aim of the higher interest rate regime is to crush working class wage struggles in the face of inflation.

Nowhere is this class war agenda more clearly illustrated than in the UK. In announcing another 25 basis point interest rate hike on Thursday, the Bank of England said there would be a “very sharp downturn” in the UK economy leading to a recession, with inflation hitting 10 %.

Unemployment would rise from 3.8% to 5.5% over the next three years, which would help moderate wage demands.

Three members of the Monetary Policy Committee who wanted a 50 basis point increase said they did so to prevent “recent trends in wage growth” from taking root more broadly and deeply. Under conditions where wages overall have not kept pace with price increases, the interest rate increases are a preemptive strike to crush an emerging movement of the working class.

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