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[SAN FRANCISCO] For all the preoccupation in the bond market about the fate of the Federal Reserve's US$2.46 trillion portfolio of Treasuries, officials may ultimately be hard-pressed to pare down holdings amassed as part of the biggest economic stimulus program in history.
Reinvestment policy is back on investors' radar as regional Fed presidents step up pressure for a debate on when to unwind emergency-era measures. More than a third of the securities come due by the end of 2019, leading traders to focus on Wednesday's release of minutes from the latest FOMC meeting for any hint that officials intend to pull back on their policy of rolling proceeds from maturing obligations into newly issued debt.
Yet fund managers Thomas Atteberry, Mark MacQueen and Daniel Dektar, whose firms oversee more than US$50 billion, say investors have little to fear as policy makers grapple with how to handle holdings that are about five times their 2008 level.
The trio says the Fed simply won't substantially scale back its government bond hoard. That's in large part a consequence of post-crisis capital rules encouraging banks to hold cash at the central bank.
The upshot is that any move by the Fed to adjust its balance sheet probably won't be as disruptive as the 2013 episode known as the Taper Tantrum, when 10-year yields soared by more than a percentage point over four months on a suggestion by then-Fed Chairman Ben S Bernanke that the central bank could soon scale back bond purchases. This time around, yields across the curve may only rise by a quarter of that, according to Deutsche Bank AG.
"They're prisoners of this and are stuck with it," Mr Atteberry, who oversees US$6 billion at Los Angeles-based First Pacific Advisors, said of the Fed's Treasury holdings.
"This is going to be a lot more difficult than an academic sitting at the Federal Reserve thinks."
Philadelphia Fed President Patrick Harker said Tuesday that there's a consensus around halting reinvestment as the best way to shrink the central bank's balance sheet, though no decision has been reached with regard to timing. The Fed also holds about US$1.75 trillion of mortgage-backed debt, securities the central bank rarely owned prior to the financial crisis and which it may be inclined to unload first.
For bond bulls, the Fed's balance-sheet policy has significant implications. While the central bank ended its asset-purchase program in 2014, keeping its pile of Treasuries constant has reduced the amount outstanding in the marketplace - helping depress borrowing costs.
Yet 10-year yields at 2.4 aren't far off the more than two-year high reached in December amid speculation the Trump administration's policies will spur quicker economic growth and inflation.
Last year, the Fed bought about US$216 billion of Treasuries through noncompetitive bids at auction known as "add-ons" to keep its holdings steady. In 2017, reinvestments will fall to US$177 billion before surging to US$425 billion in 2018 and US$349 billion in 2019.
The Fed, which has already said it favors a return to a mostly Treasuries portfolio, isn't likely to revert back to a pre-crisis level of holdings given its growing liabilities.
Post-crisis capital rules designed to keep the financial system safe have incentivised commercial banks to keep a larger swath of excess reserves parked at the Fed.
Those excess reserves, now about US$2 trillion, are a liability for the Fed that are matched on its balance sheet by assets, such as Treasuries. Another form of liability are reverse repos, in which the Fed borrows money from an expanded list of counter-parties, to offset temporary swings in bank reserve levels. Those now stands at US$338 billion.
Currency in circulation - now at US$1.5 trillion - is a third liability that makes it all but certain the Fed's portfolio won't return to its pre-crisis size of less than US$900 billion. Mr MacQueen doesn't see the balance sheet getting below US$2 trillion to US$2.5 trillion anytime soon.
"The market doesn't know how this unwind from the end of QE is going to go," said Mr MacQueen, a managing director at Austin-based Sage Advisory Services.
"But the Fed's large portfolio is here to stay."
Some questions include when the Fed will end recurring reinvestments, if it will be done at once or gradually, and whether officials will prioritise unwinding the MBS portion of the portfolio first.
Fed Chair Janet Yellen said on Feb 14 that policy makers are focused on raising rates first, setting what may be a relatively high hurdle for shrinking the US$4.5 trillion portfolio.
"The market is hungry for clues as to any developing consensus over the balance sheet," said Mr Dektar, chief investment officer of Amundi Smith Breeden in Durham, North Carolina, which manages US$10 billion in bonds.