By David Randall

(Reuters) – Another barometer of Federal Reserve hawkishness is making a bigger appearance on investors’ dashboards: quantitative tightening.

Minutes from the Fed’s December meeting released on Wednesday showed that officials had discussed shrinking the U.S. central bank’s overall asset holdings as well as raising interest rates sooner than expected to fight inflation, with “many” judging the appropriate pace of the Fed’s balance sheet reduction would be faster this time.

Investors said the hawkish signal bolsters the case for those who believe the central bank will need to act more decisively in order to contain inflation, and could fuel further bets on higher yields while continuing to shake up the growth and technology shares that powered last year’s dynamic stock rally.

“There’s a real risk that the Fed is being too aggressive here,” said Scott Kimball, co-head of U.S. fixed income at BMO Global Asset Management, who reduced his positions in high yield corporate bonds and private debt late last year, believing they will underperform as rates rise.

“If the Fed is reducing its presence in the market at the same time that its policies could choke off growth, that’s a pretty big walloping,” he said.

After Wednesday’s minutes were released, stocks continued to fall. This was due to a decline in growth and technology shares. Inversely, bond yields move with prices. The U.S. benchmark 10-year yield rose to the highest point since April 2021.

Stocks with higher yields, especially growth stocks, tend to be more expensive because they can reduce future earnings.

The taper began in November of the Fed’s $120 billion monthly purchase of bonds. A month later, it said it would aim to wrap up the taper by March rather than its mid-year target, and its “dot plot” showed a more aggressive path for rate increases than investors were expecting. That led some to wonder whether the central bank might start contemplating outright balance-sheet reductions as another tool to combat surging inflation.

Fed Chair Jerome Powell indicated after the December meeting, that even though policymakers haven’t yet decided when the balance sheets would be run-off will begin, they had made clear that those were the decisions we will turn to at the upcoming meetings.

Analysts had predicted the change. Research notes from TD analysts stated that they have a shortage of 10-year real rates due to market price in balance sheets runoff. They also said that the current rate, which is nearly -1%, was incompatible with higher Fed rates.

The real yields on ten years, Treasury yields adjusted for anticipated inflation, increased to -0.8% Wednesday.

In the meantime, the U.S. yield-curve flattened in response to the Fed minutes. It had been steepening over the past two sessions. Investors are anticipating rate hikes which push short-term rates higher.

Citi analyst said that Citi’s accelerated rate-line for balance-sheet runoff could lead to curve-steepening “as balance-sheet debate vs. rate-hike pace stirs.”

Although the Fed kept its balance sheets in an essentially stable state for approximately three years after it began its taper in 2014. The Fed may now need to act more aggressively in cutting its excess of $8 trillion in balance sheets.

Futures on the federal funds rate on Wednesday afternoon, following the release of the Fed minutes, priced in a roughly 80% chance of a quarter-percentage-point rate increase by the Fed at its March policy meeting.

“The fact that the balance sheet was discussed, and in more detail than we thought, sets the market up for possibly four rate hikes this year, and perhaps starting as soon as March,” said Kim Rupert, managing director of global fixed income analysis at Action Economics. “They are very afraid of inflation getting out of hand.”

Jason Ware, Albion Financial Group partner and chief investor officer, thinks that broad equity markets could still rise under a Fed with a stronger hawkishness, but anticipates increased volatility and a shift into more economically sensitive companies.

Ware explained that there would be “some changes beneath the surface” of the indexes.