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Is the Fed Disrupting the Bond Market?

I've seen a lot of headlines recently about investors worrying about what will happen when the Federal Reserve starts selling off this massive portfolio of bonds and mortgages they've bought over the last nine years. J.P. Morgan says it could be "disruptive", Investment News says we are "bracing" for these bond sales. My view is that the people at the Federal Reserve are a lot smarter than that.

Many people have the misconception that when the Fed says is going to reduce its holdings in bonds and mortgages that it's going to go out and sell them all in a reasonably quick period of time. That's not going to happen. What most likely will happen is that over the next five years, the Federal Reserve will allow most of the bonds that come due and most of the mortgages that get prepaid to simply expire, without purchasing new ones. This alone will significantly reduce the size of the Fed's balance sheet.

This could very well have the effect of pushing rates higher by reducing demand for bonds. What effect does that have on people? For savers, it means that you are now getting paid a little bit more for the risk you're taking. For borrowers, it means that if you haven't refinanced a mortgage or line of credit over the last three years with rates at historic lows then you should do so now.

 

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