The meeting of the American Federal Reserve in December confirmed expectations that a period of tightening monetary policy measures is beginning. Given the elevated inflation this year, which shows no signs of being transitory as the Fed had perceived in earlier meetings, along with the U.S. economy near full employment, participants are not surprised that the American central bank has decided to change its policy.
In this regard, it announced an acceleration of the closure of its bond-buying program related to quantitative easing as early as March, compared to the previously planned June. Additionally, FOMC members now expect three increases in key interest rates in 2022.
A graphical representation of the possible calendar of these events concerning the Fed meeting is below.
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Financial market participants largely expected such a ‘hawkish’ tone from Fed leaders. However, the recent emergence of the new Omicron variant of the coronavirus, which is spreading at an unprecedented rate and directly threatens the recovery of the global economy from pandemic-induced economic disruptions, has introduced a new element in assessing the consequences of tightening monetary policy and thus increased the risk of possible errors in monetary authorities’ decisions.
Namely, the tightening measures, which should primarily aim to reduce elevated inflation, will cause an economic slowdown that could simultaneously have negative consequences from a resurgence of the pandemic caused by the Omicron variant.
This potential dynamic is beginning to cause increasing nervousness among investors, as seen in the recent increase in volatility in the stock markets, particularly during a seasonally positive period for equity markets when investors typically expect a calm year-end and even a price surge as part of the so-called ‘Santa rally’ that usually occurs in the second half of December. Additionally, it is problematic for investors that the nervousness has begun to spill over from the speculative part of the technology sector, which includes rapidly growing stocks with sky-high valuations that have been sold off in recent months due to their highest sensitivity in the case of expected tightening of monetary policy.
Recently, stock prices in cyclical sectors, which were previously forecasted to perform best under the new conditions of elevated interest rates, have also come under pressure. For example, stocks in the financial sector are correcting as the yield curve is increasingly flattening, suggesting an increased risk of recession. This risk is also pressuring oil prices, causing energy company stocks to fall, and similar reasons have led to negative sentiment for stocks in the industrial and materials sectors. The resurgence of the pandemic and the reintroduction of new measures to prevent the spread of infection pose a direct threat to stocks in the consumer cyclical sector.
