The Federal Reserve’s quantitative tightening program will ramp up to its full potential in September, increasing from $47.5 billion to $95 billion per month. Some market participants are concerned this additional monetary tightening will have negative consequences on risk assets and the economy. Given that quantitative easing — buying US Treasuries and mortgage-related securities — helped firm the economic recovery and provided a lift for the stock market and other so-called risk assets, it seems quantitative tightening could have the opposite effect. But these are unusual times, and such an assumption could prove costly.
Critics of QE may downplay its effect on the economy, but it is generally accepted that the policy provided a boost to financial asset prices, especially during times of market stress. Unfortunately, forecasting stock prices is not as simple as overlaying a graph of the size of the Fed’s balance sheet assets over the S&P 500 Index.