The minutes of the interest rate meeting in March are more hawkish than market expectations, and the reduction will accelerate the upward speed of the yield of 10-year US bonds. The minutes of the interest rate meeting showed that the upper limit of the future table reduction is likely to be US $95 billion per month. Disturbed by the Russian Ukrainian issue, the interest rate could not be increased by 50bp this time. Many voting committees said that it was desirable to raise interest rates 50bp for many times at the next few interest rate meetings. We believe that the Fed will start to shrink the table and raise interest rates by 50bp at the interest rate meeting in May, which will have a more direct impact on 10-year US bonds, while the impact on US stocks, commodities and other major assets is basically controllable.
The maximum size of the Fed's monthly table reduction has been nearly tripled and will reach the maximum size as soon as August. The contents of the minutes are basically consistent with those described in the recent statement of fed vice chairman brenard. The Federal Reserve will reach the upper limit of the scale of the table reduction as soon as three months, that is, reduce US $60 billion of US Treasury bonds and US $35 billion of MBS per month, totaling US $95 billion, while the upper limit of the previous round of table reduction was only US $50 billion per month.
The interest rate hike makes the housing mortgage interest rate rise, and the Federal Reserve may accelerate the reduction process of MBS. By the end of March, the 30-year mortgage interest rate in the United States had risen 145bp over the beginning of the year, which will slow down the prepayment of MBS. Under the expectation that the Federal Reserve will raise interest rates by more than 200bp this year, the Federal Reserve will consider adopting a more radical strategy for MBS, that is, directly selling some MBS held after the table reduction process is stable.
What is the difference between the current interest rate increase cycle and the previous one? By comparing the balance sheet of the Federal Reserve, the current asset side scale of the Federal Reserve has reached US $8.99 trillion, which is almost twice that before the last round of table contraction, and the proportion of US Treasury bonds held by the Federal Reserve has also increased by nearly 10 percentage points to 68% compared with the previous round. From the perspective of the scale of US Treasury bonds held by the Federal Reserve, the proportion of short-term US bonds has increased compared with the previous period. The total debt due within two years reached US $1.77 trillion, and the weighted average maturity years was 11.28. It can be seen that the current average duration of soma is short and has the basis of rapid table reduction.
In the last round of table reduction cycle, the Federal Reserve announced the table reduction plan three months in advance, set the upper limit of monthly table reduction, and orderly table reduction by gradually increasing the monthly operation scale. In October 2014, Yellen, then chairman of the Federal Reserve, announced the termination of quantitative easing, but he was not in a hurry to start the table contraction. After the employment situation in the United States improved significantly, the Federal Reserve announced the schedule reduction plan in June 2017, and then started the schedule reduction at the interest rate meeting in September. According to the plan, the Federal Reserve initially reduced the table at the rate of reducing US $6 billion of US bonds and US $4 billion of MBS per month, and extended the overdue part. At the same time, FOMC allows the trading desk to carry out dollar roll strategy and coupon swap when necessary to promote MBS trading. After the start of the scale reduction, the Federal Reserve increased the scale of the scale reduction at the beginning of each quarter and reached the upper limit in October 2018, that is, reducing US $30 billion of US bonds and US $20 billion of MBS per month.
The main headwind factor of the contraction is the demand for reserves and liquidity in the United States. The market demand for the Federal Reserve's liabilities is one of the main factors affecting the scale of the reduction. The rapid reduction of the Federal Reserve's holdings of securities will promote the banking system to expand its securities holdings and reduce its reserves, which will then affect the liquidity of the money market. Looking back on the table contraction in 2019, excessive table contraction will lead to insufficient liquidity, make the short-term interest rate rise rapidly and force the fed to increase repurchase operations.
The impact of scale reduction on 10-year US bonds is greater than that of interest rate increase. Under the joint action of interest rate increase and scale reduction, the upside down situation of yield curve may be eased. However, we should still be vigilant against the impact of too fast table contraction and substantial interest rate increase on short-term interest rates. The too hawkish Federal Reserve may promote the upside down of 10y-3m US bond interest rate spread. Compared with raising interest rates, the reduction of the table will significantly increase the supply of US bonds, which has a more direct impact on the yield of 10-year US bonds. In 2019, when the Federal Reserve reduced its balance sheet at the rate of $50 billion per month, it encountered increased downside risks to the economy, and the interest rate spread of 10y-3m US bonds was upside down in June 2019.
The impact of the scale reduction on asset prices is limited, and US stocks and commodities are more sensitive to economic fundamentals. Looking back on history, since the Federal Reserve announced the scale reduction until the scale reached its peak, US stocks and commodities have performed well, mainly because the US economy grew well and the boom was in the upward range. During this period, the annualized yields of U.S. stocks and commodities were 16.6% and 26.3% respectively. The yield of 10-year U.S. bonds rose nearly 80bp, and the overall yield ranked as commodities U.S. stocks U.S. dollars U.S. bonds. We believe that the core logic driving various assets in the near future is still the relatively strong economic fundamentals of the United States, and we are still optimistic about the performance of the US dollar index and commodities during the year.
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