Karen Pierog, David Randall

NEW YORK/CHICAGO – After the U.S. Federal Reserve accelerated the taper of its bond purchases and revealed more aggressive rate rise projections, investors are now asking a crucial question: When will the central bank finally start shrinking its huge balance sheet?

The Fed’s shift to an inflation-hawkisher stance was largely accepted by bond investors. As was the move from $120billion per month to zero, the change to faster bond purchases had been clearly telegraphed. Also, the latest forecasts by policymakers, which have convinced market that the first interest-rate increase will come no later that May and more to follow before the year ends, were well-telegraphed.

The question remains, however: when will the Fed shift from buying more bonds to shrinking its balance sheets?

The Fed tapered its balance sheet after 2014 and kept it in an almost constant state for three years. In 2018, the Fed began shrinking its holdings by allowing certain bonds to be “run off”, without having to reinvest the principal at the maturity. This process was later known as “quantitative loosening,” or “QT.”

“Now that quantitative easing is being wound down more quickly, and the first policy rate increases are on the horizon, the ‘topic of greatest consternation’ will turn to the potential for balance sheet runoff,” said Rick Rieder, BlackRock’s chief investment officer of Global Fixed Income in a research note.

Rieder believes it is possible to start runoff in 2022, with market participants agreeing that it won’t happen before 2024.

Collin Martin of the Schwab Center for Financial Research is a fixed income strategist. He said he was paying particular attention to when Fed’s balance-sheet runoff will begin. This is because rate hikes may flatten or invert the yield curve if long term rates rise. A recession can signal an inverted yield curve.

He said, “If they allow bonds to mature and they don’t pick up the pace at which they purchase them, then that would indicate they are letting down their demand.” It could cause less demand for long-term bonds and increase yields. This would prevent the yield curve frothing too fast.

In a research note, TD analysts stated that QT will begin in March 2023.

VOLATILITY IS EXPECTED

Powell, speaking at the Fed’s press conference said that policymakers have not yet made any decision about run-off start date. However, those were the same decisions Powell will reference in future meetings.

Reaction to the Fed’s pivot was not mixed. Stocks reversed earlier losses and ended sharply higher while U.S. Treasury yields rose during choppy trading and eventually fell. [.N] [US/] [USD/]

The message that the Fed will reduce its ultra-accommodative policy was welcomed by fund managers.

“The Fed is recognizing that the economy is very hot right now and they need to move off the present setting,” said Steve Bartolini, portfolio manager for the U.S. Core Bond Strategy, T Rowe Price (NASDAQ): He stated that he was focused on bank loans and assets that would benefit from tightening cycles.

Investors saw more volatility. The ICE Index (NYSE. ) Bank of America’s (NYSE. ) MOVE index, which measures volatility expectations in bonds market markets, is still at its lowest level since April 2020.

Lon Erickson is a portfolio manager for Thornburg Investment Management. He stated that “the one thing I am confident about as we attempt to dig ourselves out from this enormous amount of stimulus” We’ll remain… cautious, hold that powder, and be prepared for any opportunities that may arise from volatility.

Jason England is the global bond portfolio manager for Janus Henderson Investors. He agreed with Jason that such tightening may cause friction in fixed income markets.

Investors still felt that the Fed was avoiding panic. This contrasts with 2013, which saw bond yields soar during the “taper tantrum”.

Brian Nick, Nuveen’s chief investment strategist said that “Nobody is talking about drastically tightening the things up.” Investors should continue to take risks in this environment.