The Fed and Market Volatility:

The Fed and Market Volatility:

After two years of record gains, U.S. stocks just posted their first negative quarter since 2020.

While many are pointing to the increase in interest rates for the rapid equity and bond market declines in Q1, there is another Federal Reserve move that we believe is far more significant and the real driver of increased volatility.

If the past is prologue, investors should position for more volatility ahead. Here’s what we’re watching

Market volatility has been on the rise this year. At its worst levels, the S&P 500 Index was down more than 12% from the start of the year before cutting those losses in half by quarter-end. There are plenty of headlines to blame. Record inflation, the Russia/Ukraine conflict, and interest rate hikes are certainly contributing to the increase in volatility. However, we believe the answer is far more straightforward: the Federal Reserve’s removal of emergency stimulus known as Quantitative Easing (QE).

In response to the Covid-19 pandemic, the Federal Reserve flooded the market with liquidity, purchasing over $4.8 trillion worth of securities and doubling its balance sheet—providing liquidity double the size of the original QE response to the 2008 credit crisis. In November 2021, the Fed began tapering that liquidity, reducing monthly bond purchases from $120 billion to $105. The Fed tapered further on December 15, 2021, cutting purchases to $75 billion every month. Finally, on March 9, 2022, the Federal Reserve quietly completed its final day of U.S. Treasury security purchases, putting an end to the latest round of QE.

We’ve seen this movie before.

The chart below compares the Federal Reserve balance sheet to the S&P 500. It highlights the stark difference in equity market returns and volatility when the Fed supports markets with liquidity—and when it does not. As shown, when the Fed’s balance sheet rises due to the purchase of securities, stocks rise with it. Each time the Fed ends QE or removes stimulus through Quantitative Tightening, volatility returns with a vengeance.


Comparing the Federal Reserve Balance Sheet with the S&P 500

S&P 500 Index vs Federal Reserve Balance Sheet


Taking a closer look, here’s what happened to U.S. equities each time the Fed scaled back QE:

  • 1: End of QE I
    The S&P 500 declined by more than 15% between March 31, 2010, and July 2, 2010, as equities suffered their first significant pullback since the market bottomed in March 2009.

  • 2: End of QE II
    The S&P 500 plummeted by more than 18% in just three months between July and October 2011. In response, the Fed announced QE III-Operation Twist to stabilize markets.

  • 3: End of QE III
    Upward momentum dried up, and volatility rose after the end of QE III. The S&P 500 suffered a drawdown of 13% between October 31, 2014, and November 8, 2016.

  • 4: First Fed Taper
    The Fed began its first attempt at removing liquidity, resulting in the “Taper Tantrum.” The S&P 500 fell by more than 19% from the highs in September 2018 to the lows in December 2018, the first 19% decline since the 2008 financial crisis.

    The Fed announced the end of the Covid-era QE asset purchases and intends to raise interest rates and remove liquidity. The S&P 500 suffers a decline of more than 12% from the January 2022 highs into mid-March 2022.

You Are Here

Knowing where you are is the first step to navigating what’s next. Without the stability provided by Quantitative Easing, advisors should expect higher volatility ahead as the Fed not only continues to raise rates but attempts to actually remove liquidity through Quantitative Tightening.

Anchor Capital offers a suite of risk-managed investment strategies and mutual funds designed to diversify portfolios and harvest opportunity- even in volatile bear markets.
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