​The Feds Afoot, and It’s Not Light-Hearted

Ivan Illán |

Though the Federal Reserve raising rates this week was widely anticipated, the additional commentary on how they plan on reducing their $4 trillion bond position was not. In February 2017, I wrote an article (“Putting the Monetary Morphine Genie Back in the Bottle”), which forecasted that the Fed would have to start selling their holdings to unwind the many years of ultra-accommodative monetary policy. This week’s Fed guidance confirms it.

The market’s reaction has been even further yield spread tightening, which happens because many are buying short-term bonds over long-term ones. Get ready for more exciting yield curve drama in the second half 2017. Most importantly, I’m very concerned about a 1994 extreme tightening yield spread scenario developing (see chart below).



Over the next few weeks, the unwinding will begin. Roughly $10 billion per month will be sold for the first three months. Most selling will be of US Treasuries (60%), the balance will be mortgage-backed securities. Then, they’ll continue the pace, adding another $10 billion every three months thereafter, until they reach $50 billion per month. Umm…. WHOA!! This is extremely aggressive, considering how very dovish the Fed has been these past two years. This amount of selling pressure will mean public debt market prices shall be headed much lower, yields (which move inversely to prices) are now set to move higher.

Per my previously mentioned Feb’17 article, most of the Fed’s balance sheet is in maturities due within the next 5 years. This means the possibility of much higher short-term rates over long-term rates, would create a most dreaded inverted yield curve scenario. No one wants that, so I’d expect we’d see clever selling across long- and short-dated maturities to manage the yield curve shape.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Comments

Emerging Growth

First Bitcoin Capital Corp

First Bitcoin Capital Corp is a Bitcoin consolidator. The Company is engaged in Bitcoin mining, payment processing, online products sales and other Bitcoin related business including transfer of crypto-currency.

Private Markets

iPRO Network, LLC

We provide the platform, tools, and resources to empower individuals and professionals to market desirable goods and services to the public, taking the place of traditional methods of commerce.

Voleo

Voleo is a free download that allows you to form investment clubs with your friends, family, colleagues, classmates, teammates…basically anyone you know and trust. Invest and manage a stock portfolio…