The first four months of 2019 have witnessed a very sharp major central bank monetary policy reversal. Most of 2018 was represented by the theme of monetary policy normalization, or a moving away of the extraordinarily accommodative policy that had been in place since the 2007-2009 financial crisis. While our thoughts for 2019 were that the Fed would remain neutral as the global economy softened, we did not foresee them giving credence to a potential cut to the policy rate in 2019 and an easing of quantitative tightening.
In March 2019, the Federal Open Market Committee announced that starting in May it would begin curtailing the runoff (quantitative tightening) from $30 billion treasury notes and $20 billion mortgage-backed securities to $15 billion treasuries and $20 billion MBS. By September, the runoff should be complete. It is not entirely clear whether the Fed will just keep letting MBS runoff and reinvest a portion in treasuries. This action gave support to the bond market.
Moreover, the Fed signaled it was open to using the power of quantitative easing as a normal policy tool. It has been known that the Fed wanted to keep a balance sheet far greater than the pre-financial crisis $800 billion. Currently, its balance sheet is approximately $3.8 trillion. In earlier discussions, the Fed indicated that it wanted to get it down below $3 trillion and wouldn’t reverse course as part of normal policy response to a weakening economy. Essentially, we thought QE was in a box with the words “only break glass in case of emergency.” Now it appears that additions to the balance sheet remain an option for recession. This was and remains very constructive for the bond market.
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