The Great Fed Unwind: It’s All About Treasury Note/Bond Sales, Not Agency MBS

By Anthony B. Sanders

The Federal Reserve was supposed to start shrinking their $4.4 TRILLION balance sheet back in October, but have only recently begun actually selling the assets on their balance sheet.

As you can see, the US Treasury 10-year Note yield was just above 4% when The Fed’s asset-buying began and after now resides at around 2.4%. And you can barely see the unwinding of the balance sheet since The Fed is moving at glacial speeds to unwind.

But we have only seen a slight uptick in the 10-year Treasury Note yield with the recent unwinding of the balance sheet (pink box).

Since The Fed’s asset purchases are primarily Treasury Notes/Bonds and agency Mortgage-backed Securities (Agency MBS), we can see that it is the T-Notes/Bonds that are being sold-off, not the Agency MBS. The Fed’s strategy is to let the Agency MBS run-off (gradually mature as mortgages prepay).

But as The Fed’s Balance unwinds and Treasury/Mortgage rates rise, mortgage prepayments are likely to slow, making The Fed’s plans less effective. This is called “extension risk.”

Let’s see what The Fed of New York does tomorrow!

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