Left Hand Not Talking to Right Hand: Quantitative Tightening & Federal Government Spending

The Federal Reserve has been raising rates at an extremely aggressive manner in 2022, taking the federal funds rate from 25bps to 4%. At the same time, they have been letting assets run off their balance sheet in quantitative tightening. This double-barreled tightening is likely contributing to the pressure risk markets are feeling.

According to my chart below, the Fed’s assets peaked at $8.95 trillion in April and have since declined to $8.68 trillion, or a cumulative drop of $270 billion. It may be no coincidence that last week markets experienced a vicious sell-off as the Fed withdrew $46B.

We don’t have a lot of history with quantitative tightening so predictions based solely on this variable may be unreliable. For example, in 2016-2019 the Fed held the balance sheet steady for 18-months and then began quantitative tightening in 2019. During this period, the S&P 500 increased from under 2,000 to over 3,000.

What factors may be mitigating the current bout of quantitative tightening and interest rate increases for that matter? Government continuing to inject money into the economy is the simple answer.