US Fed balance sheet reduction ‘once in a generation change’

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The US Federal Reserve’s confirmation that it will reduce its balance sheet is a “once in a generation change” that paves the way for the ECB to begin its tapering programme, investors say.

Chair Janet Yellen has detailed that the central bank will initially withdraw $10bn a month starting in October, but that figure will rise every three months until it reaches a withdrawal rate of $50bn monthly in one year’s time.

It currently holds $2.5trn of Treasuries and $2trn in mortgage-backed securities.

Yellen also anticipates three rate rises in 2018.

Architas investment director Adrian Lowcock notes when the programme gets up to speed the Fed will be reducing its balance sheet by $600bn a year.

“The significance of the announcement, whilst expected, should not be under appreciated. This is a once in a generation change.

The effects will mainly be seen on the US government bond curve and should push yields higher, Lowcock says.

Unigestion investment manager Olivier Marciot says their multi-asset positioning is currently underweight duration globally and even more so in non-US government bonds.

“We are long inflation breakevens and long in both developed and emerging market equities, alongside holding little exposure to the US dollar as the pace of monetary normalisation will continue to be stronger outside the US and could weigh further on the currency in the medium run,” Marciot says.

Premier Global Alpha Growth fund manager Jake Robbins says rising bond yields create an environment that is favourable for financials as they generate higher interest rates on their loan books.

Looking to other central banks, Interactive Investor head of equity strategy Lee Wild says the ECB has been careful to keep at least one step behind US policymakers for fear of over-inflating the euro.

“However, the Fed’s taper decision opens up the way for a growing Europe to begin unwinding its own colossal balance sheet,” Wild says.

Marciot adds that the Bank of Canada and the Bank of England have been surprisingly hawkish recently.

However, earlier this week Lyxor senior cross-asset strategist Lionel Melin said Brexit changed the dynamics for the Bank of England so that it would not follow the ECB and Bank of Japan in the Fed’s footsteps.