Markets Tremble at Fed’s Unprecedented Double-Edged Tightening

A rapid one-two punch of interest-rate hikes and balance-sheet reduction from the Federal Reserve risks unsettling bond and stock markets that have already taken a beating.

The effects on markets and the economy of combining the two aspects of monetary tightening in quick succession -- something it hasn’t done before -- are unknown, and investors are telegraphing their concern. The Nasdaq Composite Index slid more than 8% over the past 10 trading sessions, while Treasuries are down 2.3% this month.

“The scale of what they’re contemplating now is completely unprecedented,” said Janice Eberly, a former Treasury Department official now at Northwestern University. “It’s prudent to gauge the market reaction, especially before moving the balance sheet in concert with interest-rate changes.”

Fed Chairman Jerome Powell and his colleagues would like to see some tightening of financial conditions to take a bit of the edge off the robust economy and help bring down decades-high inflation. A retreat in asset prices after equities and home prices hit records last year would help that process, as long as it didn’t turn into a destabilizing slump that ended up hurting the economy.

Making that task trickier: The Fed has only scaled back its stockpile of bonds once before, in 2017-2019, so there’s not much to go on to try to calculate the impact of a bigger, swifter quantitative tightening this time around.