Runners pass the Marriner S. Eccles Federal Reserve building in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

Rates Traders Are Left With Questions as Fed Signals End to Runoff

(Bloomberg) -- The minutes from the Federal Reserve’s latest policy meeting appear to have settled at least one burning question with respect to the world’s most-scrutinized balance sheet, but more await.

The standout takeaway from Wednesday’s release was near-unanimous support among the members of the Federal Open Market Committee for the central bank to halt the unwind of its crisis-era asset purchases this year.

That timing provides some extra certainty, although the window still remains relatively wide and the immediate effects on rate markets have been relatively contained. Treasury yields have edged higher, but remain within recent ranges, while the curve between two- and 10-year yields steepened Thursday. The dollar rose.

The signals about potential timing will have surprised only a few outliers who saw the Fed preferring to shrink its balance sheet much more and taking it closer to pre-crisis levels. That view had grown less popular amid concerns that liquidity could be impaired, and following the Fed’s January statement that it aimed for a reserves regime with “ample supply.”

BMO’s Jon Hill said that the minutes suggest the committee “was uncomfortable with declining excess reserves potentially impacting financial conditions, and even the possibility of this channel appears to have been an impetus for the end of the rundown.”

Policy makers seem agreed about a rough timing for the unwind to finish, traders in the rates markets are awaiting answers to other questions.

Among them is what the Fed means by “ample supply,” as a guide to what level of reserves it prefers to target. The median estimate of interest-rate strategists quizzed by Bloomberg ahead of the minutes’ release puts that level at roughly $1.1 trillion. That means the Fed has $500 billion further to go and would put the total balance sheet at about $3.6 trillion.

Another mystery is just how the Fed plans to finish the unwind. Does it abruptly stop the runoff, which is currently at its peak of a maximum $50 billion a month, or will it use a tapering strategy that gradually lowers the caps -- currently $30 billion for Treasuries and $20 billion for mortgage-backed securities.

Uncertainties also surround the final composition of the Fed portfolio, including whether it will continue to hold MBS as well as Treasuries. If it does cut back on mortgage bonds, the central bank could reinvest those funds across the curve or concentrate on particular maturities.

“It sounds like they may be perfectly happy to stop the rolloff right here, which would imply to me that they may end up holding some mortgages much longer than I’d thought,” said Kathy Jones, chief fixed-income strategist at Charles Schwab & Co.

Perhaps foremost among the remaining questions is when more details will be forthcoming. On this front there’s optimism, as BlackRock’s head of U.S. multi-sector income Bob Miller expects Fed Chairman Jerome Powell should be able to provide approximate numbers and rough timing when he testifies before Congress next week.

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