Fed disinvestment policy should steepen yield curve - AmpGFX
Greg Gibbs, Director at Amplifying Global FX Capital, explains that after the Fed last week suggested that they were aiming to begin the run-off in its holdings of US Treasuries and Agency MBS late this year, after one or two more rate hikes, the pace and extent of this disinvestment is expected to be fleshed out towards mid-year.
Key Quotes
“The Fed minutes suggest it favors a gradual and smooth dis-investment.”
“Rates policy will continue to be favoured as the main lever for adjusting policy, although the Fed may decide to stop or even reverse the asset disinvestment should the inflation outlook deteriorate. As it begins the disinvestment, it may choose to raise rates more cautiously, at least initially, to assess the impact of the dis-investment. NY Fed President Dudley suggested there may be a short pause in rate hikes.”
“The prospect of disinvestment should tend to place some upward pressure on US yields, more so at the mid to longer end of the curve. Whereas the prospect of a more cautious Fed rate-hiking policy may hold down shorter term rates. The tendency should be for the US curve to steepen.”
“Rates policy might still be more influenced by the state of the economy and the inflation outlook, but, all things equal, the disinvestment process might lessen upward pressure on the USD (via less urgency to raise rates).”
“Nevertheless, curve steepening may tend to undermine currencies that are more influenced by the longer-term bond yields. This might include the JPY and higher yielding emerging market and commodity currencies; although there are no hard and fast rules on this.”
“To date, there has been no obvious steepening impact on the US yields curve, although US yields did firm late last week after the mixed US labor market report.”
“Globally, yield curves have flattened since mid-March. There may be a number of reasons for this.
- Confidence in the Trump administration to deliver on growth orientated policies, including tax reform and infrastructure spending has faded, especially in the wake of the failed vote on the Healthcare bill.
- The Fed built-up expectations for rate hikes in early-March, but then delivered a ‘dovish’ hike in mid-March, leaving its forecasts for growth, inflation and the rates path largely unchanged from their December projections.
- Oil prices fell sharply in the first half of March, reducing inflation expectations. However, they have recovered significantly over the last two weeks.
- Geopolitical risks have increased around developments in Syria and North Korea.
- The approach of the French presidential election, dovish ECB comments, ongoing Brexit uncertainty.”