Tuesday, January 18

For the phasing out of the US Fed, forget when it starts. It’s the end that matters


These days, all that is being talked about in the financial markets is when the Federal Reserve will begin to reduce its debt purchases. What’s most important, for everything from stocks to bonds to currencies, is when they will end.

There have been few major moves ahead of the Kansas City Federal Reserve Bank’s Jackson Hole virtual symposium, where President Jerome Powell on Friday can provide insight into how and when officials will begin to withdraw their support for the bond market. That will set the timetable for how soon the Fed will raise interest rates.

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The stakes are high, with cash flow flooded into the financial system that pushed US stocks to all-time highs and Treasury yields held just above six-month lows. Going back too fast could derail the economic recovery just as the rising delta raises a new risk. Moving too slow could fuel inflationary pressures unleashed by the reopening of the pandemic.

“The key for the markets is how quickly the Fed removes the accommodation, because that dictates how soon until we have none, which then translates to when the first rate hike comes,” said Tom Essaye, a Former Merrill Lynch trader who founded “The Sevens Report” newsletter.

Currently, the Fed is buying $ 80 billion a month in Treasuries and $ 40 billion in mortgage-backed securities, which the bank is expected to cut before raising interest rates. It has said it will keep those purchases stable “until substantial progress has been made towards its maximum employment and price stability targets.”

When the Fed rolled out a similar $ 85 billion a month program after the last recession, it took 10 months. The cuts were announced in December 2013 and began the following month, with the Fed detailing cuts of $ 10 billion at each policy-setting meeting, split evenly between Treasuries and mortgage bonds. The Fed closed all purchases in October 2014 and continued to raise rates in December 2015 after holding them stable for seven years.

Essaye sees the drawdown most likely starting in December and not ending until the end of 2022, which, he said, will help drive more gains in stocks and commodities and send the 10-year yield toward 2%.

Money market traders are currently assessing that the Fed will raise rates first in the first quarter of 2023, with the funds rate peaking at about 1.4%.

“When the Fed actually announces the cut, it is likely to also provide some degree of information on what pace it will take and how flexible or inflexible they want to be with the process,” said Guneet Dhingra, chief US interest rate strategy. At Morgan Stanley. “That could provide a key signal for the rate hike cycle, particularly with regard to the pace of hikes.”


Ten-year Treasury yields have fallen steadily since March and are now around 1.3%, not far from all-time lows, amid concerns that the resurgent pandemic in the US could slow the recovery. The gap between long-term and short-term yields has also narrowed since it peaked in more than five years in March, a sign of speculation that the Fed will begin to withdraw its stimulus. The prospect of higher rates has propelled the dollar, pushing the currency this month to its highest level since November, according to the Bloomberg Dollar Spot Index.

Morgan Stanley forecasts that 10-year Treasury yields will end the year at 1.8%, with the Fed beginning to decline in January and ending in October. The firm predicts that the Fed’s first rate hike will occur in the second quarter of 2023.

Steven Barrow, head of strategy for the G-10 at Standard Bank Group, said there is more risk if the Fed delays its reduction than if it moves too soon. He said a delay could force the central bank to raise rates within months of finalizing its bond purchases, which could shake up financial markets and fuel a reversal of risk that would send investors to havens like the Japanese yen and the Swiss franc.

“It would be dangerous for the Fed to do this because it needs to be in a position, from the middle of next year, to start launching the rhetoric that maybe they are raising rates,” Barrow said. “And we know that it is not out of the range of possibilities that the Fed could raise rates sometime towards the end of next year. So I’m more focused on the end point of the Fed tapering than the starting point. ”

St. Louis Fed Chairman James Bullard says he would like to see the reduction end by the first quarter of 2022. Atlanta Fed’s Raphael Bostic said it should start after some stronger labor reports and finish faster than previous episodes.

This time the stakes are higher in normalization, as the backdrop of near-zero rates and easing come together with a historic over-indebtedness and near-record duration, indicating how sensitive the bond market is to changes in the cups. That’s a risk that extends to stocks, even tech stocks that soared after the pandemic started. Cheap money that has been invested in markets around the world, reducing bond yields, has fueled a quest for yield that has sparked signs of bubbles almost everywhere.

“Liquidity at the margin is what matters in these markets,” said George Goncalves, head of US macro strategy at MUFG Securities Americas. “Therefore, the reduction will affect the assets of the periphery, starting with cryptocurrencies and including certain stocks and high-yield debt, more than Treasuries. These values ​​will have to stand up for themselves. ”

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