Investors are asking a key question after the U.S. Federal Reserve accelerated its taper of bond purchases and unveiled more aggressive rate hike projections: When could the central bank eventually start to shrink its massive balance sheet?
Bond investors had largely absorbed the Fed's pivot to a more inflation-hawkish stance. The move to a faster reduction in new bond purchases from $120 billion a month to zero had been well telegraphed, as had the new forecasts from policymakers that have now convinced the market that the first interest rate increase will arrive no later than May, with more to follow by year end.
Collin Martin, fixed income strategist at the Schwab Center for Financial Research, said he's paying attention to when the Fed's balance sheet runoff may begin, given the risk rate hikes could flatten the yield curve more or even invert it if long-term rates do not rise. An inverted yield curve can be a harbinger of a recession.
Fund managers generally welcomed the message the Fed would to dial back ultra-accommodative monetary policy. "The one piece that I'm confident of as we try to dig ourselves out of this massive amount of stimulus is volatility will remain high," said Lon Erickson, a portfolio manager at Thornburg Investment Management. "We'll stay... conservative, keep that powder and be ready for opportunities as that volatility presents them to us."
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