The Federal Reserve continues to reduce its balance sheet, and the upward trend of technology stocks may be difficult to sustain.

The Federal Reserve is reducing the money supply while tech stocks are on the rise.

These two things usually don't happen at the same time. Recent history suggests that this may be difficult to sustain.

Federal Reserve's reduction of money supply

Reducing the money supply is a key method the Federal Reserve has used in the past year to bring the inflation rate down from around 9% to 3%.

Other central banks have also reduced the money supply, withdrawing cash from the banking system and ultimately reducing consumer demand.

For example, data from Bank of America shows that the balance sheets of the Federal Reserve, the European Central Bank, and the Bank of Japan have decreased from $13 trillion a few months ago to $12 trillion, a decrease of $1 trillion.

Since March, the assets on the Federal Reserve's balance sheet have decreased by about $400 billion, to around $8.3 trillion.

However, the Federal Reserve's monetary tightening policy has already and may continue to impact the business cycle. For many companies, declining demand has squeezed sales and revenue, ultimately squeezing profits.

Surprising surge in tech stocks

Clearly, overall, profit pressure is not favorable for the stock market. But due to the impact of the Federal Reserve's tightening monetary policy on the bond market, growth stocks (many of which are tech stocks) face additional vulnerability.

Reduced money supply has decreased demand for bonds, lowering bond prices and increasing bond yields. In general, higher yields are unfavorable for many tech companies.

Data from Bank of America shows that it is for this reason that when the assets on the Federal Reserve's balance sheet shrink, the Nasdaq 100 index, which is dominated by tech stocks, also declines.

However, this time, tech stocks are on the rise. The Nasdaq 100 index has risen more than 40% this year.

It is certain that the AI boom has boosted profit expectations. For example, NVIDIA can sell more data center chips, and Microsoft and Alphabet can sell more cloud services.

Will there be a decline next?

If history repeats itself, the next move for the Nasdaq 100 index would be a decline. The last time there was a significant deviation between tech stocks and the assets on the Federal Reserve's balance sheet, a decline occurred.

In 2021, the Federal Reserve's balance sheet briefly declined but remained relatively stable for several months. During this period, the Nasdaq 100 index rose by 12% but then fell by 33%.

But history doesn't always repeat itself.

This time, tech stocks are not necessarily destined to fail. The rise is partly due to strong profit trends, rather than Wall Street's belief that the Federal Reserve is about to inject funds into the financial system.

However, the possible drag on the Nasdaq's decline could be the increase in valuation or price-to-earnings ratio.