Bank of America's Hartnett sees credit and crypto as 'next dominoes to fall' on tighter Fed policy

Published Fri, Nov 19 20212:15 PM EST

Tighter Federal Reserve policy than the market expects looks to have immediate ramifications for bonds and cryptocurrencies before spreading to stocks, according to Bank of America Chief Investment Strategist Michael Hartnett. In his weekly look at where investors are putting their cash, Hartnett calls credit and crypto the "potential next dominoes to fall" if the Fed moves more quickly to normalize its approach than the market anticipates. Hartnett sees the inflation surge pushing a more aggressive monetary policy that eventually will create volatility for stocks. He said investors especially watch asset classes that have attracted speculative money this year, such as bitcoin, which has risen more than 70% in 2021. "You end up with the idea that emerging market currencies, Treasurys – if they're joined by credit and crypto in terms of the next dominoes to drop in terms of discounting a tightening of monetary policy, then it's much tougher for equities to live in splendid isolation," he said in a phone interview subsequent to the release of his note. That will be particularly difficult if "all the other asset classes are starting to say. 'We're worried that either, A) the Fed is way behind the curve, and B) it's got to get back on the curve and that requires raising interest rates or tapering more quickly than we previously expected," Harnett added. One surprise he sees is a potentially faster "taper," or the pace at which the central bank will reduce its monthly asset purchases, with an announcement coming in December. As things stand, the Fed has signaled that beginning in November it will start reducing the minimum $120 billion a month quantitative easing program by $15 billion a month -- $10 billion in Treasurys and $5 billion a month in mortgage-backed securities. That would bring the program to an end by June. But rising inflation pressures could force the Fed's hand. Prices are increasing at the fastest pace in more than 30 years, and Hartnett thinks policymakers will have to pay heed. Hartnett's view is actually outside the house call for Bank of America: The firm's economic team expects tapering to proceed pretty much as the Fed has outlined, though stopping in May 2022 simply because the Fed could opt to finish off the program then with $20 billion Treasury cuts and $10 billion in mortgage-backed securities. However, he's not alone on Wall Street. Citigroup's economists also figure the Fed to announce in December that it is accelerating the taper pace my moving to a reduction of $15 billion a month for Treasurys and $7.5 billion in MBS. That would end the process in April. The end date for tapering is important because the Fed then could start raising rates shortly thereafter, though it's not clear when that might happen. San Francisco Fed President Mary Daly said in a scrum with reporters earlier this week that she expects there will be a period of changed "forward guidance" from the Fed following the end of tapering but before raising interest rates that would serve to brace markets for additional tightening. "You can talk about what you're going to do," Daly said. "That allows you to move the path of future rates without actually having to raise the rates." However, should the Fed be pushed into a faster pace of tightening, that eventually would hit stocks after causing ripples through other asset classes, Hartnett said. He added that "the equity market is always the last to acknowledge" tighter policy, and he sees that happening in the first half of 2022.

A man wearing a face mask walks past the U.S. Federal Reserve in Washington, D.C., the United States, on Dec. 2, 2020.

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