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Bond Market Shrugs off Fed Balance Sheet Unwind
Old 05-25-2017, 09:05 AM   #1
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Bond Market Shrugs off Fed Balance Sheet Unwind

So the Fed minutes revealed more details about the Fed's plan to finally unwind their balance sheet built up over the past QEs in 2017, something that should impact intermediate to long rates. And since it was first mentioned in early April, 5yr, 10yr Andy 30yr US Treasury rates are at the lower end of their ranges YTD. No tantrum, no panic, rates staying lower. Hard to believe it is really baked in.
https://www.ft.com/content/9ab01bec-...6-25f963e998b2
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Old 05-25-2017, 04:59 PM   #2
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Could not follow that link. FT tends to be subscriber only.

For this kind of bond market event, I need the dummies guide.
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Old 05-25-2017, 05:30 PM   #3
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I guess I hadn't exceeded my FT articles for the month - at least not on my iPad.

OK - do the Google search trick How the Fed plans to unwind massive market stimulus and you will get the article. That worked on my laptop.
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Old 05-25-2017, 05:45 PM   #4
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Anyway - I've been expecting that one the Fed starts to pull down that balance sheet built up during all the QE's, there are going to be some repercussions in the stock market. But so far both bond and stock markets seem quite sanguine about it, even though the Fed has spelled out that they actually are going to start offloading this bonds in 2017.

Quite a difference from the Taper Tantrum of 2013 where the Fed mentioning they were going to taper off buying bonds caused quite a route, but by the time the Fed had finished tapering in late 2014, interest rates had lowered again, and continued to drift down afterwards.
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Old 05-25-2017, 05:48 PM   #5
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This did work. First click on this Google search link (below), then click on the top article:
https://www.google.com/search?q=How+...utf-8&oe=utf-8
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Old 05-25-2017, 05:56 PM   #6
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Another article:
Quote:
Investors run the risk of getting caught napping when the Federal Reserve finally begins to unwind its $4.5 trillion balance sheet.

That’s the danger flagged by Mary Ann Hurley, vice president of fixed-income trading at D.A. Davisdon in Seattle. Fed policy makers are almost certain to avoid talking about the balance sheet when they release a statement at the conclusion of their two-day policy meeting on Wednesday.

“But it’s definitely going to have a negative impact on spreads because you take out a big buyer, particularly in the mortgage sector, and spreads are going to widen and rates are going to go up. Make no mistake about it, balance-sheet reduction is the same as a Fed tightening just under another name.”
Will the Fed’s balance-sheet unwind catch investors by surprise? - MarketWatch

But they did discuss the topic which they had already broached in April, and even gave an time frame of this year to start, and a method of how they would do it.

Market reaction so far - a collective yawn.

Quote:
Jim Bianco, founder and head of Bianco Research in Chicago, said many traders think the Fed won't make a move until 2020 or beyond.
"It is a mistake to conclude that the current talk means the market is fine with the balance sheet being reduced," he said.

......

To be clear, traders have been disregarding Fed projections and promises for years, and they have been right. Bond traders have consistently priced in more subdued inflation and growth forecasts than central bankers, which led to fewer rate increases than promised. This may end up serving as yet another example of how debt investors are more aware of the underlying economic reality than Fed officials.

But the fact that Fed members are becoming more vocal about their balance sheet plans is important, especially as the mix of central bankers is poised to change.

While Fed Chair Janet Yellen has a track record of adequately preparing markets for any policy shifts, her term expires next year. A new Fed leader may not be so successful at gently easing Wall Street into tighter lending conditions. Right now, bond traders are complacent about how easy it'll be to allow the Fed to unwind its historically bloated books. It's easy to see how they could be in for an unpleasant surprise.
from https://www.bloomberg.com/gadfly/art...at-their-peril
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Old 05-25-2017, 06:00 PM   #7
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The bond market is not very volatile, but it dropped going into the March FOMC meeting and has risen about 2.4% since (as measured by VBTLX).

I expect the same thing to happen around the June FOMC meeting: A drop going into it, an announcement raising FFR, then a slow climb back up for at least 1% or so.

There may be some action later in the summer when politics comes into play and Congress decides it doesn't want to increase the debt limit.
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Old 05-25-2017, 07:13 PM   #8
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Surprised the bond market is so calm on this...once the selling action begins to take place, it may be a different story.

Bond owners have benefited from overall lowering of interest rates for a generation. Lots of ups and downs along the way, but yields on 10 year treasuries have fallen from 15% to 1.5% since 1981.

If bonds start taking heat in a sustained way, anything that signals an actual bear market, the herd could get spooked and lot of damage could happen quickly. Of course, the Fed will be the largest player in the market and can ease off their selling to keep this more orderly.

It will be interesting. In case anyone is wondering, I will respond to all this action by doing...nothing out of the ordinary. Buy, buy, buy...rebalance...buy, buy, buy...
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Bond Market Shrugs off Fed Balance Sheet Unwind
Old 05-25-2017, 07:17 PM   #9
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Bond Market Shrugs off Fed Balance Sheet Unwind

Where are bond investors going to flee to? To overbought stocks or to cash equivalents paying bupkis? My VG money markets are earning less than the expense ratios. What are the more attractive alternatives?
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Old 05-25-2017, 07:24 PM   #10
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Quote:
Originally Posted by LOL! View Post
The bond market is not very volatile, but it dropped going into the March FOMC meeting and has risen about 2.4% since (as measured by VBTLX).

I expect the same thing to happen around the June FOMC meeting: A drop going into it, an announcement raising FFR, then a slow climb back up for at least 1% or so.

There may be some action later in the summer when politics comes into play and Congress decides it doesn't want to increase the debt limit.
There are many factors that influence and weigh on the bond market. the Fed announcing they will start selling is one thing. When you actually start increasing by billions of bonds at the offer prices, greatly increasing the supply, you are creating a cap on bond prices, and only putting pressure on prices to drop - it's an entirely different matter. The market may not react much now, but when it comes time to actually digest the massive portfolio....

It also depends on what other countries' interest rates are doing. If the Euro zone ever nudges them up more, then that is another large factor which will also influence our rates to rise rather than drop.
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Old 05-25-2017, 07:33 PM   #11
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Ultimately, though, where are bond investors going to flee to? Overbought stocks or cash equivalents paying bupkis?
In a rising rate environment cash would fare better than it does currently. Principle preserved and rates are improving. Not great but if you've got bonds with a duration of 5, a 2% point move would knock out 10% of the bonds value.

Weird things could also happen with commodities.

But what the heck do I know?
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Old 05-25-2017, 10:43 PM   #12
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Seems to me they are not selling, but not reinvesting any maturities...

They can slow it down a bit by reinvesting 50% or so and still start to reduce the BS...

I think it is needed... heck, I think it is way past due... at least for them to start the reduction...

The problem I see is they will probably not have the BS back to 'normal' (whatever that will be going forward) for 10 years...

That would mean that the financial crisis would have implications for at least 20 years!!! And we can be pretty sure that there will be another recession in that time frame.... the longest time between modern recessions have been 10 years... we are now 8 years out... stats would indicate one coming soon...
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Old 05-26-2017, 05:02 AM   #13
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Originally Posted by Markola View Post
Where are bond investors going to flee to? To overbought stocks or to cash equivalents paying bupkis? My VG money markets are earning less than the expense ratios. What are the more attractive alternatives?
+1. One of several unanswered ER.org topics for about 8 years now, all while bond returns have crushed cash. If you own bonds, presumably you know bond math and the alternatives...

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Old 05-26-2017, 06:34 AM   #14
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The bond rout has been right around the corner for years.
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Bond Market Shrugs off Fed Balance Sheet Unwind
Old 05-26-2017, 06:40 AM   #15
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Bond Market Shrugs off Fed Balance Sheet Unwind

Quote:
Originally Posted by Midpack View Post
+1. One of several unanswered ER.org topics for about 8 years now, all while bond returns have crushed cash. If you own bonds, presumably you know bond math and the alternatives...



I have a lot to learn on that front but, as I learn, am content to stick with my 80/20 index fund allocation with bonds in VBTLX, rebalance once per year on DW's birthday and see what happens. It's worked out well enough that I'm considering taking my talents into the hedge fund industry: https://www.barclayhedge.com/researc...und_Index.html
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Old 05-26-2017, 06:52 AM   #16
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Since the topic on bonds came up, again, I thought I would throw this article out, for some thoughts.

How Bad Could Bond Market Losses Get?
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Old 05-26-2017, 08:58 AM   #17
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Quote:
Originally Posted by canuck5 View Post
Since the topic on bonds came up, again, I thought I would throw this article out, for some thoughts.

How Bad Could Bond Market Losses Get?
The article mentioned this:
Quote:
A few years ago Vanguard performed a study to see how the Barclays Aggregate Bond Index would be affected by an overnight 3% rise in interest rates (something that has never actually occurred). They calculated what would happen if rates suddenly rose from 2.1% to 5.1% and showed the impact going out 5 years:
Table is in the article.

You can see the immediate loss would be around 13% (they also noted that the worst 12 month loss ever in bonds was -13.9% in 1974). But because the yield on bonds would now be much higher, the expected return going forward would now be around 5.1% annually, meaning the breakeven would be just over 3 years. So not exactly a crash of epic proportions.
As mentioned, this sudden 3% rise has never happened before. I think what might be missing in this calculation is that bond funds get some extra return for simple strategies like rolling down the yield curve. So the breakeven might be sooner then mentioned.

The article mentioned inflation too. One could imagine a crisis that raises inflation and rates simultaneously. War has never been friendly to bond markets. Well, I guess one could imagine anything.
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