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Markets rally as US Fed expands balance sheet; $31 billion added in the last 2 weeks

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After a brief pause, the US Federal Reserve is expanding its balance sheet again, continuing to support asset prices. The US central bank has added nearly $31 billion to its balance sheet in the past two weeks, which could explain the encouraging start to stock markets in 2022.

The size of the Federal Reserve’s consolidated balance sheet hit $8,788.3 billion on Wednesday (January 12th), down from $8,765.7 billion a week ago and just a notch below the all-time high of $8,790.5 billion. dollars on December 22, 2021.

In December, the US Fed reduced its balance sheet twice, the first and the last week of the month. The Fed action was accompanied by a selloff in equity markets, including in India, and a decline in emerging market currencies.

However, there has been a sharp rise in asset prices from their lows of last month. The benchmark Nifty50 index, for example, is up nearly 11% from an intraday low of 16,410 in December. The index closed at 18,256 on Friday. The rise in Indian equities was accompanied by an equally strong appreciation of the Indian rupee, from a two-year low of 76.34 to the dollar hit on December 15. The rupee closed at 74.16 against the dollar on Friday.

Analysts attribute the uptrend in equity and currency markets to an unwinding of the Fed’s taper trade.

“Traders in most markets had created numerous short positions during December and November of last year in anticipation of the Fed tapering. These trades are now unwinding (or hedging short positions), causing prices to rally across most risky assets, including emerging market equities, commodities and currencies,” said Dhananjay Sinha, Managing Director and Chief Strategist, JM Institutional Equity.

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He expects the short cover to end soon, which will once again lead to weakness in equity and currency markets.

In the long term, he expects the Indian stock market to remain volatile and trend lower due to Fed monetary tightening.


“Currency tapering and the rate hike followed by the US Federal Reserve will significantly slow capital inflows into the Indian market, which will weigh on equity prices and the rupee-dollar exchange rate,” he said. added.

Historically, there has been a strong positive correlation between changes in the US federal balance sheet and changes in Indian stock markets.

The correlation coefficient between the size of the Fed’s balance sheet and the Nifty50 index has been 0.95 since the beginning of April 2020, resulting in the index rising or falling in line with the evolution of the Fed’s balance sheet.

The US Federal Reserve has expanded its balance sheet by about 20%, or $1.425 billion, since the start of calendar year 2021. Over the same period, the Nifty50 index has risen by about 30%. The Fed uses these extra dollars to buy financial assets such as US government bonds, mortgage-backed securities and corporate bonds. This increases liquidity in financial markets and leads to a recovery in bond and stock prices.

According to the Federal Reserve’s timetable, it will reduce its asset purchase program by March this year and then start selling its stock of bonds in a bid to shrink its balance sheet.

Other analysts, however, say the Federal Reserve’s tapering will only have a minor impact on the Indian stock market. “The Indian market could actually outperform US equities in 2022 on a constant currency basis as the Fed cut and resulting interest rate hike will dry up share buybacks in the US market. “Stocks backed by low-cost debt have accounted for nearly 40% of the rise in US equities in recent years,” said Shailendra Kumar, CIO of Narnolia Securities.

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