For bond investors worried about what might happen when the Federal Reserve starts whittling down its $2.46 trillion of treasuries, there’s good news. You’ll barely even notice.
The central bank plans to reduce its debt holdings sometime after it starts raising interest rates, and the concern is that the Fed’s attempt to reverse its unprecedented easy-money policies will trigger a jump in borrowing costs, Bloomberg reported.
But even if the Fed doesn’t buy any bonds to replace the $216 billion in treasuries coming due next year, yields would hardly budge, according to JPMorgan Chase & Co., which looked at how much they moved during the Fed’s debt-purchase program.
“It would not have an impact, and that’s the news here,” said Lou Crandall, chief economist at Wrightson ICAP LLC, a research firm that specializes in analyzing Fed policy and treasury financing. “Letting treasuries run off is a freebie.”
It’s the latest surprise in a market that keeps confounding Wall Street’s best and brightest, who have repeatedly gotten it wrong calling for the end of the bull market in bonds.
Keeping a lid on yields is not only critical for investors, but it’s also crucial for the US government as it finances a debt load that’s more than doubled to $18 trillion since the credit crisis. And the implications extend to governments, businesses and consumers around the world as treasuries serve as the benchmark for trillions of dollars of debt globally.
Fed Reinvesting
The Fed ended its bond-buying stimulus, popularly known as quantitative easing, or QE, in October 2014, but it’s been maintaining the size of its holdings by reinvesting money from maturing debt into more securities.
In the past five years, the central bank spent almost $200 billion on reinvestments in treasuries alone.
With the US economy on the upswing, the worry is that the Fed will upend the bond market as it starts unwinding the most aggressive stimulus measures in its history.
In addition to raising rates by year-end, a majority of forecasters expect the Fed will let some debt securities mature in the first half of 2016 without plowing the money back into the bond market. Apart from treasuries, the central bank has also amassed $1.73 trillion of mortgage-backed securities and now holds a total of $4.2 trillion of bonds.
Biggest Sources
By pulling back, the Fed will start removing one of the biggest sources of treasuries demand, which has suppressed borrowing costs and helped the US recover from its worst recession in decades. Since the Fed dropped rates to rock-bottom levels in 2008 and embarked on QE, yields on the US 10-year note have decreased to about 2.20% from about 4%. It was at 2.19% in Tokyo on Monday.
“I don’t see how it can’t” push yields higher, said Thomas Simons, a government-debt economist at Jefferies Group LLC, one of 22 dealers that trade directly with the Fed.
