Kroll Bond Rating Agency Publishes Research: “For the Yellen FOMC, Duration Matters More Than Size”

NEW YORK--()--Kroll Bond Rating Agency (KBRA) has released a new research report entitled “For the Yellen FOMC, Duration Matters More Than Size.” The report makes the following key points:

  • Federal Reserve Board Chair Janet Yellen has said that “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly.” This statement is significant to investors on a number of levels, KBRA believes, but also illustrates some potential disconnects between Fed policy and the current situation in the bond markets.
  • Besides the mere increase in the size of the Fed’s portfolio, one important aspect of QE that has gone largely unremarked in the financial media is the change in the maturity or duration of the Fed’s investments.1 By purchasing longer dated Treasury and agency mortgage-backed securities (MBS), the duration of the Fed’s system open market account has grown from an average of less than two years when QE commenced to a duration over six years today. The presence of $1.7 trillion in MBS of the $4.2 trillion total Fed portfolio adds a further dimension to the analysis.
  • With inflation, demand for credit and GDP growth rates all at the lower end of expectations, KBRA believes that there is little need for the FOMC to rush to raise interest rates. To us, if Fed Chair Yellen really wants to get medium term interest rates to rise without causing a recession, then the staff of the Fed need to start thinking more like bond investors and less like central bankers.
  • KBRA believes that the goal of the FOMC should not be to increase short-term interest rates per se, but to decrease the duration of its investment portfolio and, most importantly, get the private markets to support that duration without assistance from the central bank. Otherwise, as the Fed pushes up short-term rates, the yield curve will flatten, and banks and other leveraged investors of all descriptions will suffer even further. KBRA believes that the goal of this exercise ought to be not so much about the absolute level of nominal, short-term interest rates, but rather normalizing monetary policy and interest rates without causing a precipitous expansion of credit spreads and thus an economic downturn.

To read the report, please click here.

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About Kroll Bond Rating Agency

KBRA is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP).

1 Duration measures how much a bond is likely to change in price if and when interest rates move. The longer the duration of a bond, the more it will move in price for a given move in interest rates. In a more macro-economic sense, duration represents investment assets available for purchase by market participants.

Contacts

Analytical Contact:
Kroll Bond Rating Agency
Christopher Whalen, 646-731-2366
Senior Managing Director
cwhalen@kbra.com

Contacts

Analytical Contact:
Kroll Bond Rating Agency
Christopher Whalen, 646-731-2366
Senior Managing Director
cwhalen@kbra.com