Following the Great Recession and during the COVID War, the U.S. Federal Reserve bought trillion of dollars in bonds to keep the credit market alive, seeing its portfolio peak at $8.55 trillion in May 2022.

This spring, the Fed began to let those bonds mature without replacing them. By the end of this month, the Fed’s bond holdings will be $1 trillion smaller than they were 15 months ago.

That leaves the private bond market to pick up all the new debt that the central bank has been absorbing for more than a decade.

The Fed’s exit is risky. When it tried to relinquish its bond-buying habit in 2019, lenders spooked and interest rates on new bonds spiked. However, that has not happened this time “because the global financial system is awash in cash,” the Financial Times noted.

Now, “the second trillion worth of balance sheet reduction is likely to have more of an impact,” rate strategist Jay Barry at JPMorgan told the FT. 

“The first trillion [of reductions] occurred against the backdrop of the federal funds rate moving rapidly higher,” he explained. “The second trillion matters more because it’s coming against the backdrop of a quicker increase in the pace of treasury [securities] supply.”

The U.S. has announced it will borrow hundreds of billions in the months ahead to fund the growing federal budget deficit. The private market will be expected to absorb all of it, in addition to the usual offerings of corporate and other private-sector bonds.

That is likely to cause borrowing costs to rise because the Fed as a guarantor of safety is no longer present. As yields rise, bond prices would fall, biting investors who grabbed bonds this year, expecting their prices to rise as the Fed pauses its campaign of interest rates.

Securities’ prices and yields move in opposite directions.

Businesses also would face higher borrowing costs, which could hurt this year’s stock market rally.

“All of this shuffles buyers, sellers, and the market,” Scott Skrym, a trader at Curvature Securities, said to the FT. “I expect more volatility in September and October” when the U.S. treasury begins its next round of bond issuances.

TREND FORECAST: With banks cutting back lending, the bond market is one of the few places where corporations can still borrow. With the federal government flooding the bond market, bond prices will fall and many investors will back away. Stocks’ outlook is still in doubt, which as forecast, we expect to sharply decline at the end of September/late October.

Thus, we also maintain our forecast as gold being the #1 safe-haven asset.