US: Winding down QE could weigh on bond prices

In the US, October marked the start of the Fed’s long-awaited efforts to wind down quantitative easing and the reductions in the Fed’s monthly asset purchases are initially capped at $6bn per month for Treasury securities and $4bn a month for MBS, or $10bn a month in total, a figure that will eventually be raised to $50bn, explains Richard Koo, Chief economist at Nomura.

Key Quotes

“During the unwinding process, the Fed will not actually sell any of the bonds it holds, but will simply stop reinvesting the principal payments from maturing securities. This will force the Treasury Department to issue refunding bonds to the private sector to obtain the funds to pay the Fed, a process that will have exactly the same economic impact as if the Fed had sold its own bonds to private-sector investors.”

“Nevertheless, many investors remain confident there will be no adverse market consequences since the Fed will not actually sell any of its securities. As such, bond prices may not move meaningfully until investors wake up to the mechanism described above. For the moment, at least, there has been no major sell-off.”

“Bond prices may still come under downward pressure as the Fed gradually scales back its reinvestments, and more people began to realize what is actually happening in the bond market.”

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