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Getting Ahead of the Curve: How Taper 2.0 May Affect Bond Returns

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How might the Fed’s plan to reduce its bond-buying program affect returns and risk for Treasurys and mortgage-backed securities? With the Federal Reserve’s monetary policy meeting occurring this week, the Fed might provide more clarity on its efforts to unwind its $4.5 trillion portfolio.

After nine years of quantitative easing (“QE”) – large-scale security purchases to help stimulate economic growth – the Fed announced last month that it would reduce the amount of Treasury and mortgage-back securities (MBS) it buys every month. The Fed first broached this tapering idea in May 2013, but uncertainties on how the plan would be implemented led to market turmoil in the second half of 2013, known as the “taper tantrum”

More recently, however, the Fed has made clear that it plans to pursue a conservative tapering policy and has communicated its plan more clearly. Market prices already reflect these “Taper 2.0” policy changes, resulting in low short-term volatility and a weaker correlation between the MBS spread and the Treasury bond yield. However, changes in bond regimes are possible if the market is uncertain about how the Fed will proceed.

Source : MSCI

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