Wrightson ICAP: Fed Could Shift Reinvestment Policy Tomorrow

The FOMC will “ratify the end of the taper process after a final, slimmed-down purchase cycle in February”, writes Wrightson ICAP of the January meeting.

• Doubt whether the FOMC is ready to send signal of more aggressive balance sheet action in March, so will allow taper as planned in February.
• BUT Wrightson ICAP sees a “good chance” that the Fed will “tinker” with reinvestment policy at this meeting, reinvesting MBS principal payments into Treasuries. Debatable whether reinvestments would go across the Tsy coupon curve; Waller said he favored reinvestment into short-term Tsys.
• That would mean faster runoff when the time comes and “immediately exert additional restraint on financial conditions by acting as a reverse Operation Twist”.
• Future action:“Too early to have much conviction” but assumptions are: 25bp hikes in March and June, which if well absorbed by the market, could lead to July QT announcement effective beginning August. Caps $90B month ($60B Tsy, $30B MBS) phased in over 3 months.
• Additional hikes “likely” in subsequent quarters (incl 3rd hike in H2 2022), but short-term inflation dynamics might relieve pressure on Fed in H2 2022 (toss-up whether 4 hikes this year).