Will interest rates rise sharply as the Fed shrinks its balance sheet?

I usually reserve Friday blog posts for lighter topics but with the FOMC meeting this week, I think it is important to touch on the Fed's plan to shrink its $4.5 trillion balance sheet. While the announcement was widely expected, it spelled out in greater detail plans to slowly unwind the Fed's sizable bond holdings. We believe that this step is very positive alongside interest rate hikes. The economy is doing well enough that the Fed can step back from its emergency measures, thus saving ammo for the next recession. We do not believe that this will cause a spike in long term rates but will monitor the situation closely.

Since the Great Recession, the Fed has provided the market with huge liquidity through asset purchase programs. The Fed stopped adding to its holdings in 2014 but has continued to reinvest the proceeds of maturing assets to maintain the portfolio's size.

Fed balance sheet.jpg

Fed Chair Janet Yellen announced the start of reducing the Central Bank's holdings gradually by allowing a small amount of net maturities every month. This process will likely begin in September or October, and the Fed will allow up to $6 billion in Treasury securities and $4 billion in mortgage bonds to roll off without reinvestment. These amounts will rise each quarter with the goal of having a maximum of $30 billion a month for Treasurys and $20 billion a month for mortgage-backed securities.

Markets should be unfazed by this change

Removing the Fed as a buyer of bonds is causing some concern on Wall Street that long-term rates could rise quicker than anticipated. However, the 30-year Treasury yield has actually headed lower this year despite the Fed signaling that it intends to shrink its bond holdings. On March 13th, 30-year yields were at 3.21% and on Wednesday at 2.77%.

According to FTN Financial, the Fed has been buying around $24 billion in mortgage securities a month this year and around $17.5 billion in Treasuries. To put this into context, it is a very small portion of US Treasury average daily volume. According to SIFMA, over $500 billion of Treasuries are traded per day. So even when the Fed gets to its goal of allowing $30 billion of Treasuries to roll off their balance sheet per month, that amounts to just 0.3% of the monthly trading volume. That's pretty insignificant so we don't expect a spike in rates resulting from the Fed's actions. Furthermore, if we see an increased volatility in rates, the Fed would likely step back from the situation and reassess their plans.

Hire a Better Adviser Checklist

Share This Story, Choose Your Platform!

About the Author: Chris Wang

Chris Wang


Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Runnymede Capital Management, Inc.-"Runnymede"), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Runnymede.  Please remember that if you are a Runnymede client, it remains your responsibility to advise Runnymede, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Runnymede is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Runnymede's current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: Runnymede does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Runnymede's web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Search Website

Annuity Review Database

Follow Our Podcast

Google Podcasts
Apple Podcasts

Recent Posts