Chatter Of Fed Balance Sheet Unwind Spikes Yield Curve

While the Fed watchers have been obsessing in recent weeks about the pace and size of any upcoming Fed rate hikes, summarized best by Dallas Fed president Robert Kaplan who earlier today said:

  • KAPLAN: AMONG BIGGEST DISAGREEMENTS AT FED IS ON HOW QUICKLY TO RAISE RATES

… and unexpected new buzzword emerged today, namely Fed balance sheet unwind when first Philly Fed’s Steve Harker noted it in his speech earlier this morning…

  • HARKER: WHEN RATES AT 1%, NEED TO LOOK AT UNWINDING BAL SHEET

followed later in the day by St. Louis Fed’s James Bullard who, likewise, hinted that selling Fed assets may be coming soon:

  • BULLARD: BAL SHEET ROLLOFF MAY BE BETTER THAN AGGRESSIVE HIKING

Of course, how credible it is that the the Fed may actually engage in this is anyone’s guess: should the Fed “unexpectedly” start to reduce its balance sheet, the impact on global yields would be devastating, and make the Taper Tantrum and the TanTrump seems like child’s play in comparison. Which, perhaps, is why today for the first time we got not one but two such “trial balloons” from two separate Fed presidents, just to gradually acclimate the market with the concept of upcoming balance sheet normalization.

The mechanics of such a process are rather mindboggling, especially coming at a time when even the Republicans are pushing to layer on an addition $9 trillion in US government debt over the next decade, which – all else equal – would mean require more QE to monetize the deficit, precisely the opposite of selling Fed-owned Treasuries.

Then again, the Fed has been known to make major, and quite public, mistakes. Whether this is one of them, and whether it is intentional remains to be seen, however the sharp steepening in the curve that has taken place today amid the sudden Fed talk of Fed balance sheet unwinding, is very much unmistakable.

The only (perhaps rhetorical) question is how such an unwind won’t impact stocks far more than bonds. And then we remember that nothing can possibly ever have an adverse impact on stocks, and all is again well with the world.


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