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US yields capped as Fed takes note of limited market tolerance
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In the January meeting the Fed not only put rate hikes on hold, but also signaled an earlier end to balance sheet unwinding, acknowledging financial market volatility and the risks to growth. We now expect the run-off to end already at the end of the year, leaving the Fed’s assets at around 3.7 US$ tn. The Fed will then likely tilt the portfolio composition toward shorter-dated Treasuries in order to enhance its power as a crisis-fighting tool. The Fed also announced its readiness to adjust the runoff process in case of a serious downturn. While Quantitative Easing had a clear impact on asset prices, the effect of tightening appears at present more muted. A key reason is that the balance will shrink from a peak of 25% of GDP to 18%, still three times the pre-crisis level. The remaining balance sheeting tightening is expected to contribute up to 15 bps to higher 10-year US yields. However, the dominant factors for US Treasury yields in the medium term are seen to be the slowing of the US economy and the expected end of the Fed hiking cycle.