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By G. Steven Bray
All eyes are on the Federal Reserve again this week as it meets to discuss monetary policy. The Fed isn’t expected to change interest rates at this meeting; however, markets do expect it to announce when it will start reducing its massive portfolio of Treasury and mortgage bonds.
The Fed already has broadcast the details of the plan, which actually won’t result in the Fed selling any bonds. Instead, it will buy less, allowing run off to slowly reduce the portfolio over time. Less Fed buying could put a little upward pressure on rates in the coming months; however, given that markets have known the plan’s details for a while, I suspect current bond prices already reflect that.
I think it’s more likely reduced Fed buying will weaken its shock-absorber effect. Positive news, such as higher wages or world peace, normally lessens the demand for bonds, but the Fed has been there for most of the past decade to pick up the slack. Without the Fed, rates may bounce a little higher on such news.
I think markets will pay more attention to the Fed’s post-meeting rate projections and Fed head Yellen’s press conference. Last week’s inflation report, which showed the first uptick in a while, gave the Fed a little cover if it chooses to raise rates again this year. I’m sure markets will be very interested to know what Yellen and the other governors think about the prospects for inflation going forward. Should the Fed drop its recent concern over persistently low inflation, rates could jump.