The market’s initial response to the FOMC minutes implies a mildly dovish interpretation. Some investors found comfort in the idea that the balance sheet runoff may conclude this year. Others are unconvinced that this is what the fed intended to signal. The rationale is that the fed only signaled that an announcement would take place this year, rather than a firm 2019 end date. Considering the following quotes from the minutes, I think it’s clear that they do indeed intend to end QT this year.
Page 10 “Against this backdrop, the staff presented options for substantially slowing the decline in reserves by ending the reduction in asset holdings at some point over the latter half of this year and thereafter holding the size of the SOMA portfolio roughly constant for a time so that the average level of reserves would fall at a very gradual pace reflecting the trend growth in other Federal Reserve liabilities.”
Page 11 “Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.”
Another interesting point is that some participants may prefer to continue reducing the portfolio’s MBS holdings while reinvesting in treasuries only. This could push mortgage spreads wider over time.
Page 12 “Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities.”
To me, the biggest question from here is; WHEN in 2019 will QT end? While the fed has communicated its willingness (and perhaps its intention) to end QT this year, a whole 10 months remain in 2019. Given the current cap of $50B/month, the amount of reduction can actually wind up exceeding that of 2018. Remember, the cap (max monthly reduction) didn’t hit $50B until October 2018. There hasn’t been a big market response to the minutes, but this may not wind up being as supportive as it seems on the surface.
Matt DeLorenzo, Fixed Income Strategist