Unwinding The Fed’s Balance Sheet A Real High Wire Act

Posted on Posted in Bonds & Fixed Income

A review of the 10-year Treasury note’s weekly trading chart indicates that the secular bull market in bonds may have already concluded. Therefore, relief rallies should not be mistaken for encores and instead regarded as exit opportunities from the market gods. In fact, the most recent rally coming off of key support levels appears to be failing as price action week-to-date suggests a resumption of the bearish trend initiated back in Q4-2016.

Of course, underlying fundamentals or the “perception of such” are what ultimately drive the longer term direction of interest rates and bond prices.¬†With regards to “perception of fundamentals”, the most influential source is the Federal Reserve, which convenes today and tomorrow to determine monetary policy going forward. The consensus opinion is that it will not hike rates.

 

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The elephant in the room is how and at what pace does the Fed conclude the unprecedented QE policies it implemented in response to the 2008 recession. No one knows or can say with certainty if it can smoothly exit from a staggering $4.5 trillion portfolio of debt without any negative impact on the asset bubbles it created. A quick glance at the 10-year treasury spread over shorter term rates would tend to suggest some cause for concern or caution is warranted, which is how historically lower spreads are typically interpreted. This is truly a high wire act for Chair Yellen and her colleagues as it must balance policy message against policy and soaring stock prices against tamped down expectations for Q3-2017 GDP @ 2.4%.

 

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Related Securities: Although no charts for the 20-Year+ Treasury Bond ETF (TLT) and the 7-10 Year Treasury Bond ETF (IEF) are included in this posted article, their price action has accordingly mimicked the movements of the 10-Year Treasury Note. In like manner, both have violated the uptrend of their relief rallies and may be heading to test support at their respective levels of $116.50 (TLT) and $103.50 (IEF).

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