In the FOMC minutes released yesterday, it said that 'a change to the Committee's reinvestment policy would likely be appropriate later this year', provided that the economy continued to perform about as expected.
We still expect the Fed to begin quantitative tightening in Q1 18 (when the Fed funds rate will be in the range of 1.25-1.50%, i.e. halfway the long-term neutral rate at 3.00%, according to the latest projections) although risk is skewed toward earlier (possibly in December).
Consensus both among investors and analysts was for mid-2018 in the most recent surveys. We think an announcement on what could trigger quantitative tightening is likely in connection with the June meeting.
The latest minutes indicate that the FOMC members 'generally preferred to phase out or cease reinvestments of both Treasury securities and agency MBS'. In this publication, we assess some of the potential fixed income implications:
In our view, the spill-over to Treasury yields from a reduction in the Federal Reserves' balance sheet by phasing out or ceasing reinvestments of the MBS prepayments and/or scheduled repayment of principals should be modest.
The potential steepening pressure induced by phased out or ceased reinvestments of maturing Treasuries relies heavily on the Treasury's issuance pattern going forward, but should be moderate compared to the 'taper tantrum' in 2013.
Besides, a too excessive quantitative tightening could lead to temporary tightening of financial conditions, offsetting a potential steepening pressure.
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