The Fed is about to make history Wednesday, and so far, the market has yawned.
Some strategists say that creates the opportunity for a sudden wake up call and a rush of volatility when the Fed releases its statement at 2 p.m. Fed Chair Janet Yellen briefs the media at 2:30 p.m. ET.
Chances are that the market continues to have a muted response, but some bond pros say the announcement could also jolt the markets one way or other, depending on the Fed's tone and its forecast for interest rates.
The Federal Open Market Committee is expected to announce Wednesday afternoon that it will start to reverse quantitative easing, the massive bond buying program it initiated during the financial crisis to save the economy. Now with $4.5 trillion in assets on its balance sheet, the Fed is taking the step of moving away from the final stages of that program, which has been to replenish those bonds as they mature.
"It really is peculiar. You have the Fed doing this, you don't even know who the chairman is going to be in the next couple of months, you have a chance for a fairly decent change in tax policy…The bigger story is there's no market reaction to much of anything lately," said Michael Schumacher, director of rate strategy at Wells Fargo.
He said if the Fed announcement goes as expected, yields could first move lower for a week or two and then rise, based on the past reaction to Fed interest rate hikes.
"It's a first, and you can tell I'm hedging because the Fed has never done this," he said. "Longer term, it really opens Pandora's box. The Fed has never done anything like this. Really no big central bank has done this."
The Fed plans to shrink its balance sheet in a slow and steady process. Even though quantitative easing, or QE, ended long ago, the Fed has been keeping liquidity high with its purchases to replace maturing securities. The Fed plans to slow down those purchases to replace bonds and mortgage securities at an initial pace of $10 billion a month, increasing it by that same amount each quarter until it reaches a total of $50 billion.
"It is, at least in our assessment, a little surprising the market has not really responded more to the expectations for overall balance sheet reduction," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. "While the total amounts will start small, they're going to increase pretty quickly. Next year we're going to have $230 billion that comes off the Treasury portfolio and $150 billion that comes off the mortgage portfolio… By the end of 2021, you're looking at a cumulative impact of $1.4 trillion. The market should be efficient and be pricing it in already."
Reference: CNBC
Read More: https://www.cnbc.com/
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