An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst
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Even with the bond market's muted response to the Federal Reserve's plan to begin winding down its almost $4.3 trillion portfolio of mortgage and Treasury securities, there are plenty of reasons why the calm probably won't last.While the three rounds of Fed asset purchases that became known as quantitative easing sapped volatility, former Fed Chair Ben Bernanke's comments in May 2013 that the central bank was considering scaling back purchases showed how quickly that can change.MBS SUPPLY/DEMAND SHIFTThe Fed owns $1.77 trillion of agency mortgage-backed securities, about 31 percent of the market.Since the Fed concluded quantitative easing in October 2014, the spread between Fannie Mae 30-year current coupon and Treasurys has been sitting between 90 and 114 basis points, below its historical average of about 137 basis points. Fed tightening would push up the effective fed funds rates, also reducing prepayment speeds and increasing the average duration of the securities.Assuming that Treasury ramps up bill supply, rates on debt maturing in less than one year would likely rise, forcing up the overnight rate on Treasury repurchase agreements.
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