The bond crash takes on a new dimension

The flight of the dove causes a bond crash… The US yield market received another shock on Tuesday after the extremely restrictive statements by Lael Brainard, yet one of the most compliant governors in the Federal Reserve. After President Jerome Powell, who… cleared the way for an ascent Fed funds rate by 50 basis points (bp) at the next meeting of the Monetary Policy Committee (FOMC), the future Fed vice-chairman has thrown a stone in the pond by announcing a rapid winding down of the institution’s balance sheet, from the month of May.

The market reaction was immediate. The US Treasury 10-year Treasury yield rose 10 basis points (bps) in minutes and rose over 17 bps during the session to 2.57%, the most significant daily gain since March 2020. – Annual yields are now at a peak since May 2019, rising 70bps in one month. The yield on the 5-year bond rose by 17 bps to 2.71%, the highest level since the end of 2018. The 2-year yield rose by 10 bps, indicating a slight steepening of the curve US rates for 2-10 years. This new entry into weakness is accentuating the losses of the US interest rate market, which was already the most significant in a decade at the start of the year: at the end of March, the overall performance was already 5.5% negative.

Accelerated “quantitative tightening”?

Investors worry that the Fed is lagging too far behind inflation and that it will need to act much more vigorously. The price increase was 7.9% year-on-year in February in the United States, and the Fed-controlled PCE index rose 6.4% over the same period. During a speech at the Minneapolis Fed, Lael called Brainard on Tuesday “primordial” task of reducing inflationary pressures. She added that the FOMC “will continue to methodically tighten monetary policy through a series of rate hikes and begin to contract the balance sheet at a rapid pace from the May meeting”

Until now, the market was relying on an announcement of a balance sheet reduction (quantitative tightening, QT) at the meeting of 3 and 4 May, but before a start of implementation in June or July. As the economic recovery is faster than in previous cycles, the pace of deleveraging should also be stronger than in 2017-2019. The Fed halted its purchases in March, while raising Fed fund rates by 25 basis points For the first time since the beginning of the health crisis.

The central bank’s balance sheet today stands at $9 trillion. Analysts at the Bank of America (BoA) predicted in a note released March 14 just before the last FOMC that the Fed could cut its balance sheet in phases by accelerating at a cut of $1 trillion a year over a period of four years. three years. The loss of significant support to the markets should put pressure on yields, which could exacerbate the weak liquidity in the Treasury market. In particular, the debate focuses on the progressivity of the QT via the non-reinvestment of securities that mature each month. Should the Fed bring securities back to the market, including mortgage-backed securities (MBS), which it isn’t? made in 2015

Through his intervention, Lael Brainard seems to indicate, as some fear, that we will have to go faster. With its new status, it may have anticipated the release of the minutes of the Fed’s latest meeting, expected Wednesday evening.

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