Tech stocks and cryptocurrencies – which have soared during the easy-money area – are in dire straits now that the Federal Reserve is shrinking its balance sheet by nearly $9 trillion.

The Fed Is Ending its Liquidity Binge

According to the most popular responses from 687 contributors to the latest MLIV Pulse survey, the broad outlook for Wall Street and beyond is that tech stocks and crypto will struggle as the Fed begins to trim its holdings this month in a process known as quantitative tightening.

The historic shift is seen by many as a notable threat to tech stocks and crypto. The two risk-sensitive assets have soared in Covid-era market mania, before plummeting in the cross-asset crash this year.

The era of ultra-cheap money seems over, at least for now. The Fed’s balance sheet reduction is expected to last more than a year, while nearly two-thirds of survey respondents say the four-decade bull run in Treasuries is over.

These events are all occurring against the backdrop of the Fed riskily raising interest rates at the fastest pace in decades to tackle runaway inflation, as officials seek to quash talks of a September pause.

Recent swings in stocks, bonds and other markets have done little to deter the US central bank from its hawkish stance, with policymakers expecting them to hike rates another half point on June 15. The Fed began reducing its balance sheet this month by allowing assets to mature without reinvestment at a monthly rate of $47.5 billion, subsequently rising to $95 billion per month in September.

Meanwhile, central bankers from Canada to Europe are poised to test the resilience of global markets as they follow hawkish U.S. policymakers on a cash-sapping mission to end the financial frenzy purchase of bonds during the pandemic.

Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said on Bloomberg Television: 

“It’s where that quantity of capital and quantity of liquidity has been most beneficial that its withdrawal is going to continue to be felt — and that is in the most speculative parts of the market.”

The Fed’s Moves Are a Threat to Tech Stocks and Crypto

The MLIV survey of riskiest assets in the quantitative easing era surveyed a group ranging from retail investors to market strategists. Just 7% of respondents chose mortgage-backed bonds – securities that were at the heart of the 2008-09 financial crisis – with almost half citing technology and crypto. 

Removing money from the system tends to tighten financial conditions, which acts as a drag on economic growth. This can reduce the valuations of technology stocks given their reliance on optimism about future earnings.

The Fed ending its bond purchases also forces the Treasury to sell more debt in the open market, which could put upward pressure on bond yields. As this plays an important role in how Wall Street values publicly traded companies, it is a headwind for growth stocks in particular.

The Nasdaq 100 index, which is heavily weighted in tech stocks, has soared more than 130% from its March 2020 low, boosted by pandemic-era policy easing before plunging this year. 

Meanwhile, cryptocurrencies have increasingly been driven by swings in tech stocks. There has been a strong positive correlation between the Nasdaq 100 and Bitcoin since March 2020 and the relationship strengthened during this year’s selloff.

The idea is that when money is cheap, traders can massively speculate on future digital trends. However, when the liquidity binge wears off, those bets get more expensive.

Matt Maley, chief market strategist for Miller Tabak + Co said:

“I don’t think people fully realize how much QE caused investors to add a lot of leverage to their positions. Now that we’re going through QT, that leverage has to be unwound.”

Respondents who were invested in the market during the financial crisis more than a decade ago are particularly worried that the reduction in the Fed’s balance sheet will hurt junk bonds. Newer entrants to the market are more likely to be concerned about its impact on crypto and tech stocks.

Violent Trading Conditions May Occur

Readers are sounding the alarm bells more widely about global trading conditions as the European Central Bank and the Bank of England also seek to rein in their expanded balance sheets. The two institutions are meeting this week to discuss action, as well. Nearly 53% of respondents said they fear markets are underestimating the importance of central bank liquidity outside of the United States.

Only 8% of surveyors described QT in general as overestimated. Yet, the primary concern for MLIV readers remains how much the US central bank will raise benchmark borrowing costs over this cycle. Approximately 61% said the level at which the terminal federal funds rate peaks is more important than the amount by which the balance sheet contracts.

When it comes to QT’s endgame, around two-thirds say the main catalyst is more likely to emerge from negative developments than from a win on the inflation front. Some 38% said economic difficulties would lead to an end to the balance sheet meltdown, while 20% pointed to market turbulence.

Only 10% voted for issues related to bank reserves and short-term funding markets. It’s an implicit vote of confidence in the steps the Fed has taken to avoid the bottlenecks in the financial plumbing that led it to intervene in 2019 during its previous tightening program.

For many, the era of ultra-low rates and large central bank balance sheets is all they have known professionally. Some 46% of MLIV respondents were not active in the markets before the widespread adoption of quantitative easing globally in the aftermath of 2008.

Fewer still have surfed the first long-term Treasury bull market in recent decades. A strong majority of readers (64%) believe the four-decade bull run is finally over, with experienced market participants significantly more hawkish than their younger counterparts.

Ed Moya, senior market analyst at Oanda said, “Whenever you’re seeing major shifts in liquidity, there’s potential you could see some disruption in the market and that could trigger some violent trading behavior.”

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