MBS to lead Interest Rates

Macro Perspectives: Thu 19 Aug 2021

We got the minutes from the July Fed meeting yesterday.

It's well known, now, that the Fed has been discussing the reduction of the bond buying program, to begin in the fourth quarter. The minutes confirm that, though the tone was far from hawkish. Conversely, if we listen to Jim Bullard, not a voting member this year, but a vocal rational voice from the Fed, he has been publicly acknowledging the risks that inflation could come in much hotter than the Fed has positioned for.

Probably not a coincidence, Bullard had some well timed comments just before the July Fed minutes were released.

He warned that the Fed might ultimately be forced into "inflation fighting mode." He said growth is robust, labor markets are as tight as they ever get, and he said that firms are successfully passing higher input prices along to consumers.

In my previous note, we talked about Fed Chair Jay Powell's admiring commentary on Paul Volcker's battle and defeat of the Great Inflation of the early 80s. Bullard brought up Volcker too, saying that the Fed is already behind the curve on inflation, as compared to Volcker-era actions.

So, again, given the somewhat dull tone from the Fed minutes (which are nearly a month old now), it's probably no coincidence that Bullard is rolled out to inject something closer to reality for the markets to chew on.

And looking back at some of Bullard's commentary over the past two months, he's made the point that the Fed doesn't need another housing bubble. With that, of the $120 billion a month of bond purchases currently being executed by the Fed, $40 billion are mortgage backed securities. Expect the Fed to exit that market first (in the coming months). That should put the brakes on the aggressively rising housing market.