Fed firms grip on US$2.5trn stack of Treasuries

Bloomberg

The Federal Reserve’s liftoff from near-zero interest rates in December sparked angst over how quickly the central bank would start whittling down its US$2.5 trillion hoard of Treasuries.
It turns out that investors in the world’s biggest bond market had little cause for concern. The weaker-than-forecast labour report for May wiped out bets that policy makers would follow up on their year-end move and raise rates when they meet on Tuesday and Wednesday. What’s more, traders now see less than a 50 percent chance of the next increase coming this year. The shift in expectations is significant because New York Fed President William C Dudley said in January that officials anticipate keeping the holdings stable until normalization of rates is ‘well under way,’ though he said there was no specific level for the Fed’s target at which reinvestment would end. For bond bulls, confidence that rates will stay lower for longer means one less reason to worry about owning Treasuries with yields approaching record lows.
“It’s safe to say that not only is ending reinvestment further off the radar, it’s not even on the radar,” said Brian Svendahl, Minneapolis-based senior portfolio manager of fixed income at RBC Global Asset Management, which oversees about US$290 billion. “There is certainly no urgency now.”

Plans Clarified
Officials made clear well over a year ago that they had no plans to sell any of the debt on the Fed’s balance sheet, accumulated in a bid to support the economy after the financial crisis. Instead, they’d look to reduce holdings eventually by halting reinvestment of principal payments as bonds came due. Under current policy, the Fed will plow about US$216 billion of proceeds from maturing securities into new Treasuries over the course of this year. Next year, the central bank has US$194 billion maturing, followed
by US$389 billion in 2018. The Fed is the biggest holder of the
government’s debt.
A year ago, Dudley said he’d like to see rates rise to a “reasonable level” before ending the rollover policy. Such action by the Fed would amount to additional “tightening of monetary policy” and should come only when the funds rate was at about “1 percent, or 1.5 percent,” he said.
At the end of 2015, most policy makers anticipated reaching that range within 12 months. Fed officials’ median forecast in December was for the policy rate to rise to 1.375 percent in a year. The projection for the end of 2016 fell to 0.875 percent as of March.

Playbook Tossed
Futures traders see a much slower path. The implied probability of another quarter-point increase this month has fallen to zero, from 22 percent on June 2, the day before the release of the May payroll data.
The chance of a rate boost by
year-end has dropped to 47 percent. The effective funds rate, now at 0.37 percent, won’t reach 1 percent for at least another three years, overnight index swap data compiled. “Whatever playbook the Fed had, I think they’ve torn it up,” said Thomas Graff, who manages US$4 billion of debt at Brown Advisory Inc in Baltimore.
“The consternation around the first hike last year plus the consternation ahead of the second hike means maybe things have changed. So I don’t want to be doing anything that relies on strategy of the world’s central banks.”
In April, primary dealers expected it would take 18 months for the Fed to change its reinvestment policy, at which point the funds rate would be in a range from 1.25 percent to 1.5 percent, according to the median response to a survey by the central bank.
“You really don’t need to worry about this now,” said Svendahl at RBC Global Asset Management.