Our CIO and Chief U.S. Equity Strategist Mike Wilson explains the
significance of the Fed’s decision to resume buying $40 billion
of Treasury bills monthly.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist.
Today on the podcast I’ll be discussing the Fed’s decision last
week and what it means for stocks.
It's Monday, December 15th at 11:30am in New York.
So, let’s get after it.
Last week's Fed meeting provided incremental support for our
positive 2026 outlook on equities. The Fed delivered on its
expected hawkish rate cut but also indicated it would do more if
the labor market continues to soften.
More important than the rate cut was the Fed's decision to
restart asset purchases. More specifically, the Fed intends to
immediately begin buying $40 billion of T-Bills per month to
ensure the smooth operation of financial markets. Based on our
conversations with investors prior to the announcement, this
amount and timing of bill buying exceeded both consensus, and my
own expectations. It also confirms a key insight I have been
discussing for months and highlighted in our Year Ahead
Outlook.
First, the Fed is not independent of markets, and market
stability often plays a dominant role in Fed policy beyond the
stated dual mandate of full employment and price stability.
Second, given the size of the debt and deficit, the Fed has an
additional responsibility to assist Treasury in funding the
government, and will likely continue to work more closely with
Treasury in this regard.
Finally, the decision to intervene in funding markets sooner and
more aggressively than expected may not be ‘Quantitative Easing’
as defined by the Fed. However, it is a form of debt
monetization that directly helps to reduce the crowding out from
the still growing Treasury issuance, especially as Treasury
issues more Bills over Bonds.
At the Fed's October meeting, it indicated some concern about
tightening liquidity which I have discussed on this podcast as
the single biggest risk to the bull market in stocks. Evidence of
this tightness can be seen in the performance of asset prices
most sensitive to liquidity, including crypto currencies and
profitless growth stocks.
While the Fed probably isn't too concerned about the performance
of these asset classes, it does care about financial stability in
the bond, credit and funding markets. This is what likely
prompted it to restart asset purchases sooner and in a more
significant way than most expected.
We view this as a form of debt monetization as I mentioned, given
the Treasury's objective to issue more bills going forward. More
importantly, these purchases provide additional liquidity for
markets, and in combination with rate cuts, suggest the Fed is
likely less worried about missing its inflation target. This is
very much in line with our run it hot thesis dating back to early
2021. As a reminder, accelerating inflation is positive for asset
prices as long as it doesn’t force the Fed’s hand to take the
punch bowl away like in 2022.
Ironically, the risk in the near-term is that this larger than
expected asset purchase program may be insufficient if the Fed
has materially underestimated the level of reserves necessary for
markets to operate smoothly. This is what happened in 2019 and
why the Fed created the Standing Repo Facility in the first
place. However, this is more of a tool that is used on an
as-needed basis. What the markets may want or need is a larger
buffer if the Fed has underestimated the level of reserves
required for smoothly functioning financial markets.
To be clear, I don’t know what that level is, but I do believe
markets will tell us if the Fed has done enough with this latest
provision. Liquidity-sensitive asset classes and areas of the
equity market will be important to watch in this
regard, particularly given how weak they traded last Friday
and this morning.
Bottom line, the Fed has reacted to the markets' tremors over the
past few months. Should markets wobble again, we are highly
confident the Fed will once again react until things calm down.
Last week's FOMC meeting only increases our conviction in that
case and keeps us bullish over the next 6-12 months, and our 7800
price target on the S&P 500. We would welcome a correction in
the short term as a buying opportunity.
Thanks for tuning in; I hope you found it informative and useful.
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