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Four Reasons Why the Fed's Balance Sheet Unwind Shouldn't Rock the MBS Market

By Advisor Perspectives
Capital Markets

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Market participants increasingly expect the Federal Reserve to begin unwinding its balance sheet during the second half of 2017, and many have speculated that the agency mortgage-backed securities (MBS) market – and the U.S. housing market more broadly – could suffer as a result.

For context, the Fed owns approximately $1.75 trillion of agency MBS, accounting for roughly 29% of the market and an even larger percentage of tradable float (agency MBS actively circulated in the market and not held by banks, government-sponsored enterprises, etc.). While those numbers are significant, we believe the agency mortgage market is unlikely to exhibit massive volatility as the Fed begins to reduce its unprecedented footprint, for four key reasons:

A mindful Fed. The Fed is actively trying to avoid disrupting financial markets as it reduces accommodation, as evidenced by its carefully telegraphed, measured hiking of short-term interest rates. We expect the Fed to take a similar approach to balance sheet reduction, telegraphing its moves and exiting extremely gradually, likely by tapering reinvestments as opposed to ending reinvestments entirely or selling bonds outright.

Read more at Advisor Perspectives.

Photo: Jukka Zitting

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