In recent weeks, the two themes capturing the most attention from financial markets have been 1) the tax reform effort, and 2) the White House nominee for Fed Chair. In addition to fiscal policy (tax reform) and monetary policy (Fed leadership), the narrative could be expanded to include inflation and real growth. These factors had generally provided a boost to financial markets over the last several weeks, but the tailwinds subsided somewhat in late October.
Following months of anticipation, the FOMC finally announced the initiation of its balance sheet reduction plan on September 20, and as many expected, the market reaction was muted. Fed leaders did a good job of telegraphing the move in the prior months, and the pace of reinvestment tapering will begin at relatively small levels before ramping up over the next four quarters. As such, agency MBS spreads actually tightened modestly immediately following the announcement.
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Despite much headline noise related to political and geopolitical matters, the financial markets remained relatively calm throughout August. The S&P 500 was down as much as 1.8% by mid-month but ended the month slightly positive, and interest-rate volatility, both realized and implied, held near historically-low levels. That said, there are still several potential headwinds that could revive volatility from a nearly catatonic state.