It’s been a tough start to the new year for bonds. Most 2022 outlooks from the largest broker dealers and asset managers called for another tough year for fixed income as the Fed removes accommodation, even if tapering and rate hikes had mostly been priced in already. As we discuss in our January Monthly Market Commentary, the real wild card related to Fed policy in 2022 is balance sheet normalization. Some of the more hawkish members of the FOMC have suggested that the Fed may need to let the balance sheet shrink this year as another response to inflation risks. During the last quantitative easing cycle, the Fed waited three years after ending tapering before letting its securities portfolio roll off, so doing it inside of 12 months this time around would expectedly have a material impact on financial asset valuations. 
To that end, the minutes of the December 15 FOMC meeting were released yesterday, and it further fueled the sell-off in bonds. To be clear, there were no true revelations provided, but this is a skittish market at the moment. The minutes suggested that the March meeting is live for a rate hike if needed, which we already knew from the December meeting itself, but the big area of interest was the reference to balance sheet reduction. “Some” suggested that a “significant amount of balance sheet shrinkage could be appropriate over the normalization process.” This shouldn’t be surprising given the above reference to hawkish Fed leaders (Bullard, Waller, etc.) making similar comments of late, but the obvious risk is that “some” becomes “many.”  As such, public speeches by Fed leaders over the next couple of months will be even more closely scrutinized for hint of how various FOMC participants (particularly voting members) are leaning on the topic. 

​​​​​​​Jason Haley
Chief Investment Officer