Yields Up Slightly After Fed Statement

Today’s Fed statement basically put markets on notice to expect a June increase barring any unforeseen negative economic news and/or major risk events (geopolitical, etc).    The Fed is viewing recent soft economic reports (1^st quarter GDP, lower inflation, weaker consumer spending) as being “transitory” and seasonal, not structural.    The 10 year T jumped up slightly up to 2.32%, partially due to “relief selling” as a government shutdown is being averted for now.  September could get dicey as the 2018 budget year must be funded with both sides girding for battle and a debt ceiling deadline looming.  Note that these potential legislative battles and brinkmanship may make it difficult for the anticipated September increase by the Fed.  Another factor is the long awaited shrinking of the Fed balance sheet is starting to be discussed.  They are floating “trial balloons” indicating an intention to curb reinvestment of existing bonds (Treasuries and Mortgage Back Securities) in the portfolio as they mature.   This could lower the now $4.5 trillion balance sheet to about $2.8 to $3.0 trillion.   The Treasury has already issued a guidance note that it may be increasing the supply of new Treasuries as rates will rise due to increased supply.  Many economists feel that the balance sheet trimming needs to occur after a few more increases in the short term rate to avoid major disruption in the financial markets.   Of course, its all theoretical as the massive quantitative easing “experiment” was unprecedented and we are in “uncharted territory”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners.