{"id":42265,"date":"2017-03-29T07:00:55","date_gmt":"2017-03-29T11:00:55","guid":{"rendered":"http:\/\/www.ino.com\/blog\/?p=42265"},"modified":"2017-03-27T20:04:09","modified_gmt":"2017-03-28T00:04:09","slug":"what-happens-when-the-fed-starts-selling","status":"publish","type":"post","link":"https:\/\/wwwtest.ino.com\/blog\/2017\/03\/what-happens-when-the-fed-starts-selling\/","title":{"rendered":"What Happens When The Fed Starts Selling?"},"content":{"rendered":"<p style=\"margin: 0 0;\"><img loading=\"lazy\" decoding=\"async\" src=\"\/\/www.ino.com\/blog\/wp-content\/uploads\/2014\/12\/GeorgeYacik_Contributor_ImageBadge350.png\" alt=\"George Yacik - INO.com Contributor - Fed &amp; Interest Rates\" width=\"350\" height=\"131\" class=\"alignleft size-full wp-image-30496\" style=\"padding-top: 10px;\" srcset=\"https:\/\/www.ino.com\/blog\/wp-content\/uploads\/2014\/12\/GeorgeYacik_Contributor_ImageBadge350.png 350w, https:\/\/www.ino.com\/blog\/wp-content\/uploads\/2014\/12\/GeorgeYacik_Contributor_ImageBadge350-300x112.png 300w, https:\/\/www.ino.com\/blog\/wp-content\/uploads\/2014\/12\/GeorgeYacik_Contributor_ImageBadge350-270x100.png 270w\" sizes=\"(max-width: 350px) 100vw, 350px\" \/><\/p>\n<p style=\"margin: 0 0;\"><br style=\"clear:both;\"><\/p>\n<p>The financial markets have been fixated for years at the prospect of interest rate increases by the Federal Reserve but have largely ignored the $4.5 trillion elephant in the room, namely the Fed\u2019s gargantuan balance sheet. But last week several members of the Fed began publicly discussing their support to finally start winding down that massive portfolio.<\/p>\n<p>Way back before the global financial crisis, the Fed\u2019s portfolio held pretty steady in the high $800 billion to low $900 billion range. Then, as the crisis hit full force in the last three months of 2008 after the Lehman Brothers collapse, the portfolio more than doubled, ending that year at slightly north of $2 trillion. While the worst of the crisis may have been reached at that point, that was only the beginning of the balance sheet\u2019s growth.<\/p>\n<p>Between the end of 2008 until the end of 2012, the Fed\u2019s portfolio grew gradually by another $800 billion or so, before spiking again, adding another $2 trillion over the next two years as the Fed embarked on quantitative easing. Eventually the portfolio reached $4.5 trillion, including both Treasury and mortgage-backed securities, at the end of 2014, where it has held largely steady ever since.<!--more--> <\/p>\n<p>It\u2019s likely that most investors have largely ignored the size of the Fed\u2019s portfolio because it\u2019s just simply too big and ugly to contemplate, so why worry about it? It\u2019s kind of like the national debt, now approaching $20 trillion. We\u2019ll never pay it off, so who cares? And if a branch of the government \u2013 independent or otherwise \u2013 owns a big part of the debt, what\u2019s the problem?<\/p>\n<p>The problem is if the Fed were to start unloading that portfolio. How exactly would the bond market react if the Fed were to start selling off some of it? We may be about to find out.<\/p>\n<p>At the Fed\u2019s March 15 meeting, at which it voted to raise the federal fund's target rate by 25 basis points, only one member dissented, namely Neel Kashkari, the new president of the Minneapolis Fed, who wanted to keep rates on hold for now. <\/p>\n<p>In a subsequent essay on the bank\u2019s website, entitled \u201c<a href=\"https:\/\/www.minneapolisfed.org\/news-and-events\/messages\/why-i-dissented\" target=\"_blank\">Why I Dissented<\/a>,\u201d Kashkari did bring up the unthinkable, namely that the Fed should come up with, and disclose, its plan for eventually trimming its balance sheet. Maybe it\u2019s something we should be thinking about too.<\/p>\n<p>\u201cI do not believe adjusting the balance sheet should be a regular policy tool,\u201d Kashkari said in his long essay, of which discussion about the balance sheet took up only a small portion.<\/p>\n<p>\u201cInstead, I believe we should begin the normalization process soon. The first step to normalizing the balance sheet, in my view, is to publish a detailed plan of how exactly we will shrink the balance sheet and when that roll-off will begin. I think it is imperative that we give the markets time to understand the details of the plan before it is implemented.\u201d<\/p>\n<p>\u201cWhile it is likely the announcement of that plan will not trigger much of a market response, we don\u2019t know that for certain,\u201d he added, ominously. \u201cThe announcement of our balance sheet plan could trigger somewhat tighter monetary conditions. In that case, that announcement could be viewed as a substitute for a federal funds rate increase, whose magnitude is uncertain. After it has been published and the market response is understood, we can return to using the federal fund's rate as our primary policy tool, with the balance sheet normalization under way in the background.\u201d<\/p>\n<p>He must have struck a chord, because at least four other regional Fed presidents last week chimed in on a subject that before then seemed almost taboo \u2013 but now looks like it may get more serious consideration.<\/p>\n<p>\"We should be allowing the balance sheet to normalize naturally now, during relatively good times, in case we are forced to resort to balance sheet policy in a future downturn,\" St. Louis Fed President James Bullard said last Friday. On Thursday, San Francisco Fed President John Williams said he wants to let the Fed's balance sheet begin shrinking by late this year.<\/p>\n<p>That followed Cleveland Fed President Loretta Mester, who said last Tuesday that she would be \u201ccomfortable changing our reinvestment policy [on mortgage-backed securities, of which the Fed owns about a third of the entire amount outstanding] this year. Ending reinvestments is a first step toward reducing the size of the balance sheet and returning its composition to primarily Treasury securities over time.\u201d On the same day, Dallas Fed President Robert Kaplan said, \"I think we are moving toward a period where we should begin allowing the balance sheet to gradually and patiently run off.\u201d<\/p>\n<p>Is there fire behind all this smoke? Probably. At least we know that the Fed is at least thinking and talking about it, which means the process could start faster than many believe \u2013 even this year, according to Williams. In addition to actual rate hikes, this would put further upward pressure on interest rates, and downward pressure on bond prices.<\/p>\n<p>Is your bond portfolio prepared for that?<\/p>\n<p>Visit back to read my next article! <\/p>\n<p><a href=\"http:\/\/www.ino.com\/blog\/meet-george-yacik\/\" target=\"_blank\">George Yacik<\/a><br \/>\nINO.com Contributor - Fed & Interest Rates<\/p>\n<p><span style=\"font-size: 12px; font-style: italic;\">Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.<\/span><\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>The financial markets have been fixated for years at the prospect of interest rate increases by the Federal Reserve but have largely ignored the $4.5 trillion elephant in the room, namely the Fed\u2019s gargantuan balance sheet. But last week several members of the Fed began publicly discussing their support to finally start winding down that [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":16,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6920],"tags":[8853,6824,7308,2672,7333,8491,4542,8854,3197,8852,8856,8855,5442],"class_list":["post-42265","post","type-post","status-publish","format-standard","hentry","category-ino-com-contributors","tag-fed-balance-sheet","tag-federal-open-market-committee-fomc","tag-federal-reserve-chair-janet-yellen","tag-financial-crisis","tag-geroge-yacik","tag-james-bullard","tag-john-williams","tag-loretta-mester","tag-mortgage-backed-securities","tag-neel-kashkari","tag-regional-fed-presidents","tag-robert-kaplan","tag-the-federal-reserve"],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v23.4 (Yoast SEO v23.6) - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What Happens When The Fed Starts Selling? - INO.com Trader&#039;s Blog<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/wwwtest.ino.com\/blog\/2017\/03\/what-happens-when-the-fed-starts-selling\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"What Happens When The Fed Starts Selling? - INO.com Trader&#039;s Blog\" \/>\n<meta property=\"og:description\" content=\"The financial markets have been fixated for years at the prospect of interest rate increases by the Federal Reserve but have largely ignored the $4.5 trillion elephant in the room, namely the Fed\u2019s gargantuan balance sheet. 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