• According to the minutes of the Fed’s June meeting released this week, the Federal Reserve has reached a consensus on how it will begin the process of reducing the size of its balance sheet. Although participants “expressed a range of views about the appropriate timing” to begin the process, markets appear to be prepared for an announcement at the Fed’s September meeting.1
  • In an attempt to avoid any potential taper tantrum-like market reactions, policy makers have insisted that the balance sheet reduction process, once it begins, will be uneventful. In May, Patrick Harker, President of the Federal Reserve Bank of Philadelphia, referred to it as “the policy equivalent of watching paint dry.”1
  • The combination of additional rate hikes this year and next, along with balance sheet reductions, seems likely to tighten financial conditions and could cause long-term rates to rise.
  • Portfolio duration, which measures the potential impact a change in interest rates will have on a bond’s price, may become a renewed consideration for fixed income investors as we potentially enter a new phase of Fed tightening.
  • To this end, it is important to note the diverging duration paths that investment grade bonds and high yield bonds have taken over the past approximately 18 months. For example, investment grade bonds’ duration has slowly risen since the beginning of 2016, from approximately 5.8 to 6.2 years.2 During the same time frame, high yield bonds’ duration has gradually decreased, from approximately 4.2 years to 3.7 years.2

1 U.S. Federal Reserve, http://bit.ly/2tN37BN.
2 Bloomberg. As of June 30, 2017.

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