U.S. Government Bonds Strengthen as Fed Outlines Gradual Portfolio Tapering
May 24 2017 - 4:15PM
Dow Jones News
By Sam Goldfarb and Katy Burne
U.S. government bonds strengthened Wednesday after the Federal
Reserve suggested it would likely start reducing its bondholdings
later this year in a more cautious manner than some had expected,
while laying out early details of a proposed method for tapering
the portfolio down.
Nearly all Fed officials at the Fed's May 2-3 meeting agreed
that the central bank should start shrinking its $4.5 trillion in
Treasury, mortgage bonds and other securities this year, barring
any unexpected changes to the economy and its interest-rate policy,
according to minutes released Wednesday.
Fed officials said they are leaning toward an approach that
would be gradual, with monthly announced changes to the amount they
intend to reinvest back into the bond market from maturing
securities. Setting monthly limits, or caps, for how much they can
reinvest would reduce the portfolio in a "gradual and predictable
manner," they said, reducing the risk of market disruption.
Federal Reserve Bank of Philadelphia President Patrick Harker on
Tuesday told an audience in New York he hoped it would be the
"policy equivalent of watching paint dry."
Fed officials have previously talked about taking a steady
approach to shrinking the portfolio, also known as the central
bank's balance sheet.
Still, traders greeted the new details warmly after a long
period of anticipation. The yield on the benchmark 10-year Treasury
note settled at 2.266%, down from 2.285% Tuesday. Yields fall as
prices rise.
Minutes from the Fed's meeting also showed officials thought
that it would "soon be appropriate" to raise short-term interest
rates again, despite a slowdown in economic growth in the first
quarter and some recent softness in inflation. Still, traders
appeared mostly focused on the balance sheet plan, said Blake
Gwinn, U.S. interest rates strategist at Natwest Markets. Though
still preliminary, the plan could lead to an unwinding of the Fed's
balance sheet that would be "a little more stretched" out than many
analysts had expected, he said.
Others said the Fed needed to provide additional details of its
methodology soon to keep markets calm. The balance sheet plans
leave "a lot of wiggle room," said Peter Tchir, managing director
in strategy at Brean Capital LLC, a securities broker. "I expect
they will get us some numbers by the September time frame and they
will do everything they can to mitigate any market fears."
The pace of declines in the balance sheet would increase over
time under the Fed's leading proposal. The amount of runoff allowed
each month would start small and be phased higher every three
months, the Fed said in its May minutes. Certain situations could
cause the Fed to make adjustments, it added.
Most Fed officials support starting the unwinding sometime this
year, something they reiterated in the May minutes and said they
planned to continue discussing at their June meeting. The timing of
when they release additional details is important because they want
to give investors plenty of advanced warning, but also not be tied
to specific economic data points or dates.
Federal Reserve Bank of Minneapolis President Neel Kashkari said
Tuesday he wanted the central bank to announce more specifics on
its balance sheet plans soon. "I want us to put out a detailed
plan," he said. "Just to take the uncertainty away and let that go
on in the background" while the Fed focuses on the level of
short-term interest rates.
Before the financial crisis, the Fed's bond portfolio was just
under $900 billion, or 6% of gross domestic product, and consisted
mostly of U.S. Treasurys. Buying Treasury and mortgage bonds
through three rounds of asset purchase programs was designed to
lower long-term rates and juice the economy after the crisis hit.
Today, the Fed's balance sheet is around 23% of GDP.
The Fed wants to shrink it again to give itself enough headroom
to buy more bonds in another downturn because its benchmark
federal-funds rate isn't far enough away from zero to be lowered
again much further.
Slowing its reinvestments in the bond market would force the
U.S. Treasury to sell more bonds to other buyers, potentially
depressing their prices without the Fed standing ready to buy. At
the same time, the Treasury could fulfill its borrowing needs by
issuing debt of different maturities, making it difficult to
project the exact fallout from the central bank's actions, some
analysts say.
For now, the Fed is reinvesting proceeds from maturing Treasury
and mortgage bonds back into new bonds, keeping the size of its
portfolio roughly constant.
Write to Sam Goldfarb at sam.goldfarb@wsj.com and Katy Burne at
katy.burne@wsj.com
(END) Dow Jones Newswires
May 24, 2017 17:00 ET (21:00 GMT)
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