Firstly, there are those who suggest that the last stage of the equity bubble of 1999/2000 and subsequent crash was encouraged by the Fed being petrified by the unknowns of the Y2K. They pumped in a huge amount of liquidity into the financial system in Q4 1999 which saw a big increase in the money supply and the Fed balance sheet (seen in Figure 1). However, as the Y2K bug failed to materialise, they withdrew all that liquidity. However, by then it was too late, they had lit the touch paper for the last stage of the bull market and while there are many potential reasons for the bubble bursting (including record valuations), there is a strong case to be made that the injection of, and then the withdrawing of, large liquidity was a big contributor to the end phase.
…QT from 2017-2019 hardly had any impact on equities overall as you can see in the second chart but there was a large sell-off in Q4 2018 until Powell sharply pivoted on continued Fed hikes in January 2019. So, QT and hikes certainly interrupted the long equity bull market. For bonds, they initially sold off during QT but rallied hard in the second half of QT, mainly from when the equity market sold off in Q4 2018, and continuing after the Powell dovish pivot.
So, if we do get QT in 2022, will it be more like 1999/2000 or 2018/2019? Both were tough for markets but on a very different scale. We now have US equity valuations that are only rivalled in history by what we saw in 1999/2000. However, before we get too excited, liquidity is still very high and, as we saw in 2018/2019, it took a year of QT and a series of rate hikes to create major market problems….
… Regardless, it seems that the age of ultra, uber, ludicrously loose monetary policy is coming to an end. It's inevitable markets will be impacted. The timing is more debatable. In our 2022 Credit Outlook (link here), we had a notable H1 widening on the Fed accelerating tightening beyond expectations but only a temporary one while the market adjusts. The economic problems of tighter policy probably won't be fully felt for a couple of years.
SO the message of these CoTD(s) is that age old adage and a reminder of how policy works with a lag…
