To The Moon

On Wed, 08 Jan 2025, the Fed released its FOMC’s December 2024 minutes of meeting (MoM).

It revealed a more complete picture than what is already known and also stealthily foretell sectors’ stocks that might face challenges in the near term.

This research gave us a much better understanding of the situation. It also helped us identify some company stocks in certain industries that investors should avoid for now.

MoM’s Content.

Back in November 2024, US banks have told New York Fed that they expect the Fed's quantitative tightening (QT) exercise that had begun in June 2022, to taper in May 2025.

Based on May 2025 timeline, the banks further estimated, with QT enforced, the Fed will hold about $6.375 trillion in assets, leaving the banks to shoulder around $3.125 trillion in reserves, that is slightly more than they have now ($2.9 trillion).

Delving into the December 2025’s MoM, it could be seen that Wall Street's biggest banks have revised their expectations, repositioning the Fed’s QT exercise to end a month later in June 2025 instead.

December 2024 MoM : (what’s already known)

• Interest rate cut by -0.25% to between 4.25% & 4.5%.

• Number of projected interest cuts (in 2025), reduced to 2 from 4.

• Raised their estimated path for inflation.

The Fed did not change its plan for reducing its money supply.

Instead, they made a small adjustment to how they pay interest (on its reverse repo facility) to encourage banks to hold less money with them and instead lend it out to businesses & individuals.

The MoM’s update on the outlook for the Fed’s balance sheet comes as traders hope 2025 is the year, the Fed ends its QT exercise.

A Bit Of History.

The need for QT stemmed from the Fed’s amassing twice the amount of bonds’ holdings into 2022 via Quantitative Easing (QE) exercise.

The Fed had adopted an aggressive spate of bond buying during the Covid-19 pandemic; injecting liquidity into the market, to prevent it from collapsing.

With Covid-19 a thing of the past, the Fed has been working hard to mop up the excess liquidity by doing the reverse, ie. selling its bonds.

Its consistent effort has effectively reduced its holdings to just under $7 trillion from a peak of $9 trillion.

Ultimately, the Fed hopes to:

• Reduce liquidity (in the market) to a level where money market achieves a normal amount of volatility.

• Achieve an equilibrium interest rate, so that it could be used as a tool to help regulate US economy momentum.

The Challenge.

The Fed faces a tough challenge. It is difficult to know exactly how much money to take out of the economy.

Too much, it can result in major disruptions in the financial markets.

To avoid this, the Fed has been careful in slowing the pace of its balance sheet drawdown (selling of bonds holdings).

More Challenges.

The Fed faces several “major” uncertainties in 2025.

(1) Returning President's spendings.

• Not knowing how much Mr Trump intends to spend, makes it harder to predict how much money the government will need to borrow, affecting the Fed's actions.

(2) Private Repo Market.

• There have been problems in the private market for short-term loans, causing big swings in prices. Some banks even had to borrow money quickly from the Fed to stay afloat.

(3) US Government Debt Limit.

• The Fed is very worried about the US government's debt limit.

• If borrowing limit is breached, it could make it hard for the Fed to understand how much money is available in the system.

• If and when the government cannot borrow as much (aka back-in-force debt limit), banks might end up parking a lot of their money with the Fed instead of lending it out.

My viewpoints : (mine only)

Bear with me as I try to explain my way through.

Chain reaction.

With QT, the Fed sells its treasury bonds in exchange for cash, effectively removing money from the financial system.

With less money available, banks have less to lend to businesses and customers. Less bank loans mean less revenue generated.

When the Fed sells bonds, supply of bonds (in the market) increases. This can lower bond prices, leading to higher bond yields (interest rates).

Sectors affected by QT.

Quantitative tightening (QT) by the Fed for longer can have significant repercussions, on various sectors.

Based on historical data & analysis, top 3 sectors most affected by QT are:

(1) Financial sector.

• QT can lead to higher interest rates, that can impact banks and other financial institutions by increasing borrowing costs and reducing profit margins.

• Eg. $JPMorgan Chase(JPM)$. $UBS Group AG(UBS)$

(2) Real Estate.

• Elevated interest rates (for longer) can lead to higher mortgage rates, that can reduce demand for real estate and negatively impact real estate investment trusts (REITs).

• Eg. $Simon Property(SPG)$

(3) Utilities.

• Utilities are often seen as bond proxies due to their stable dividends.

• Higher interest rates can make bonds more attractive compared to utility stocks, leading to a potential decrease in demand for utility stocks.

• Eg. $American Water(AWK)$.

Impact on abovementioned sectors’ stocks will depend on (a) how smoothly the Fed executes its balance sheet reduction and (b) how the broader US economic environment evolves, under the new Trump administration from 20 Jan 2025 onwards.

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