Markets have had a shaky start to the year, thanks in large part to expectations that the Federal Reserve could raise interest rates in the coming months. It could also shrink its massive balance sheet by the end of the year.

Given what happened to assets the last time the Fed tightened, we can understand why investors were nervous. As this chart from Deutsche Bank’s excellent Jim Reid highlights, the last period of Fed tightening in 2017/18 was followed by asset classes with negative total returns. highest ratio. Aike:

As Reed put it:

Timing is almost impossible without a bit of luck, but if the Fed does start to aggressively pursue a series of rate hikes and QTs as it seems likely, a full market correction is likely at some point.

There may be more uproar this time around.

The debt burden is now greatly increased. According to the Global Debt Monitor report from the Institute of International Finance, global debt in the third quarter of 2021 was close to $30 billion, or 350% of GDP. That’s up from about $25 billion in 2018, or about 320 percent of global GDP.

Combine that with the wave of activity in more murky areas like cryptocurrencies, and it’s not hard to imagine a plethora of people, businesses and governments being exploited to the extreme. Even relatively small changes in the price and quantity of credit can have a significant impact on prices. As margin calls are issued, a vicious cycle of selling and further margin calls can occur.

In addition to this, there is another risk. If inflation persists, the scale and pace of Fed tightening could exceed current expectations.

The federal funds rate is now about 8 percentage points lower than the last time inflation was above 6%:

That was before we expanded the size of our balance sheet. Here’s how the Fed’s current time series has inflated since it began in 2002:

It is likely that, with debt so high, credit may not need to be as expensive as it used to be to dampen demand and keep inflation in check.However, as Edward Price warning here, for the real economy, the appropriate federal funds rate may still be well above what the market can bear.

With Greenspan approaching his 35th birthday, the assumption that U.S. monetary policy makers will pull back on tightening if markets are turbulent is ingrained in investors’ minds.

But nothing lasts forever. Decades of low inflation have given U.S. central bankers room to soothe investor nerves. At some point, price pressure will become prevalent. When they do, the Fed’s stance could change in a more aggressive way than the market expects.