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The Federal Reserve is starting to reduce its balance sheet after a prolonged period of cheap lending.
Let’s recall that after the Recession, the Federal Reserve bought more than $4 trillion dollars of mortgage and Treasury bonds to encourage borrowing. Then, in May of 2013, Fed chairman Ben Bernanke announced the Fed would stop buying new securities.
His announcement agitated the credit markets. The 10-year Treasury climbed over 130 basis points, and equity market volatility spiked. Yet, this didn’t end the Fed’s accommodative monetary policy. From 2014 through September of 2017, the Fed keep its balance sheet constant: meaning, if $100 billion of mortgage securities matured, the Fed purchased $100 billion of new securities. This helped keep interest rates low.
The Fed, however, dramatically reserved course at the end of 2017. In September, then-chairwoman Janet Yellen announced the Fed’s plan to slowly unwind its balance sheet. Beginning in October, it started allowing $10 billion of securities to roll off its books. And this January, it doubled the size of its tightening. By year end, the Fed intends to reach a pace of $50 billion per month.
This process some are calling “quantitative tightening” will effectively withdraw liquidity from global credit markets and put pressure on interest rates. So, what does this mean for investors? With the Fed no longer actively suppressing rates, traditional fixed-income products will face pressure. In this environment, we believe an actively managed credit portfolio focused on floating-rate loans may be best positioned to generate income with downside protection.