Fed Risk May Be Underestimated as Traders Focus on Trump Policies - StanChart

As the U.S. presidential election heats up, traders have been fixated on the potential policy changes that a new administration could bring. However, Standard Chartered (StanChart) warns that the risk associated with the Federal Reserve's (Fed) monetary policy may be underestimated. The bank's research team, led by David Mann, highlights that the Fed's actions could have a more significant impact on markets than previously thought.



The Fed's balance sheet and income, as well as the System Open Market Account's (SOMA) unrealized gain or loss position, are sensitive to various interest rate paths and macroeconomic outcomes. Stochastic simulations using the FRB/US model show that the Fed's balance sheet size is projected to decrease as interest rates rise, due to quantitative tightening (QT). This reduction in the balance sheet can make it more difficult for the Fed to implement accommodative monetary policy in the future, as it has less firepower to purchase assets and increase the money supply.

Moreover, the Fed's net income is projected to turn negative temporarily as interest rates rise, due to the increase in interest expenses on its liabilities and the decrease in interest earnings on its assets. The SOMA portfolio is projected to experience an unrealized loss position as interest rates rise, due to the decrease in the market value of its long-term securities holdings. These factors can impact the Fed's ability to conduct monetary policy and its income, which in turn affects its ability to remit funds to the U.S. Treasury.



Key factors driving the Fed's net income and the SOMA portfolio's unrealized position include interest rates, the size of the Fed's balance sheet, and the composition of the SOMA portfolio. These factors interact with each other, with changes in interest rates affecting the Fed's net income and the SOMA portfolio's unrealized position, while the size of the balance sheet and the composition of the SOMA portfolio can amplify or mitigate these effects.

In conclusion, while traders focus on the potential policy changes that a new administration could bring, the risk associated with the Fed's monetary policy may be underestimated. The Fed's balance sheet, income, and the SOMA portfolio's unrealized position are sensitive to various interest rate paths and macroeconomic outcomes, which can impact the Fed's ability to conduct monetary policy. Traders should pay closer attention to the Fed's actions and their potential implications for the market.