Yesterday, the dollar showed steep growth versus the basket of currencies, and the US stock market edged lower amid a new package of anti-Russian sanctions and Governor Lael Brainard's speech. Brainard said that the central bank could raise interest rates more aggressively and would start to reduce the balance sheet already in May aiming to dampen the high rate of inflation.
The US Federal Reserve is expected to hike rates throughout 2022. Moreover, there could be several 0.5% increases. In other words, the regulator is prepared to act more aggressively to take inflation under control. The current state of the American economy makes it possible to tighten monetary policy. Above all else, the central bank is likely to start reducing the balance sheet, which has soared to $9 trillion in recent years. What does reducing the balance sheet mean? It means the Federal Reserve will sell its Treasury and mortgage bonds, the process opposite of monetary policy tightening. In other words, an excess of liquidity in the American financial system will be withdrawn, which can also help dampen high inflation.
"Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–19," Brainard said. More Fed representatives are now prepared to vote for aggressive actions. In this light, the US equity market is likely to be in a corrective move in 2022-2023. Stocks already tumbled at the beginning of the year but then managed to partially recoup losses. For example, Apple and Tesla are now hovering around their all-time highs. However, further rate hikes and the reduction of the balance sheet are likely to lead to another correction. In addition, the bubble in the equity market could burst at any time. Whether it happens or not, there definitely should be a correction. Meanwhile, according to Esther George, president of the Federal Reserve Bank of Kansas City, the regulator plans to bring the interest rate above the neutral level of 2.5%. This means we could see interest tares at a 2.5% level by the end of the year.
