Friday, June 1, 2018
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US Treasury Market
Date	1 mo	3 mo	6 mo	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr	30 yr
5/24/18	1.74	1.91	2.09	2.28	2.50	2.65	2.82	2.93	2.98	3.06	3.13
5/25/18	1.70	1.90	2.07	2.27	2.48	2.60	2.76	2.88	2.93	3.01	3.09
5/29/18	1.77	1.93	2.06	2.17	2.32	2.43	2.58	2.71	2.77	2.87	2.96
5/30/18	1.77	1.94	2.08	2.23	2.42	2.53	2.67	2.79	2.84	2.93	3.01
5/31/18	1.76	1.93	2.08	2.23	2.40	2.54	2.68	2.78	2.83	2.91	3.00

                                                                                      Source: U.S. Department of the Treasury, as of 05/31/18  

Turbo Charged Fed Tightening…
 

In October of 2014 the Fed ended QE3.  The monthly outright purchases of mortgage backed securities (MBS) had grown their MBS portfolio to around 1.7 trillion.  After this date, the Fed continued to buy MBS but with only the monthly principal cash flow it received from its existing MBS and Agency bond portfolio.

We all know that the Fed has started raising rates on the front end of the curve, but in October 2017, the Fed also started a program to reduce the size of their massive balance sheet.  This process of balance sheet normalization, or “reverse QE”, is done by gradually reducing the amount of monthly purchases of mortgaged backed securities it makes with the monthly principal payments received from its existing holdings of MBS and Agency debt.

The graph below shows the total amount of all agency mortgage backed securities issued since 1997.  The combination of the Fed buying MBS each month along with a drop off in total MBS production has helped to keep mortgage rates low and spreads tight on MBS securities.  Now, with reverse “QE”, the Fed is gradually removing its bid for MBS and putting upward pressure on mortgage rates.    

The combination of the Fed raising rates on the front end of the curve (another 25 bps increase expected in June) along with reverse “QE” balance sheet reduction on the longer end of the curve (increased mortgage rates) creates a compound tightening effect.  The question is, how much “Turbo Tightening” can the economy take?



Source: Bloomberg

 

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