Since the beginning of the COVID-19 pandemic, the Federal Reserve (Fed) has been supporting the depth and liquidity of financial markets by buying U.S. Treasury and mortgagebacked securities (MBS) each month. However, meeting minutes from the December 2021 Fed policy meeting indicated that the Fed may begin to reduce the size of its balance sheet in 2022.
Prior periods of Federal Reserve balance sheet reduction/runoff (2018 to 2019) did not result in negative performance across the core fixed income sectors. Treasuries, MBS, and corporate bonds all performed well.
The spread, or required compensation investors require above Treasuries, of mortgage-backed securities widened during the 2018-2019 period, while corporate bonds spread levels remained relatively unchanged.
However, there is still considerable uncertainty on how balance sheet runoff will be structured and implemented. Additional provisions were put in place recently (most notably the Fed’s standing repo facility), which should prevent the same negative market reaction we saw in 2019.
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