RATE REVERSAL – 2/14/22

The only other time the Fed shrank its balance sheet was in 2018, and rates declined, the opposite of what should have happened. Here is maybe why. As the Fed shrinks its balance sheet it sells bonds and acquires cash and importantly, destroys it. That reduced liquidity increases risk, which causes investors to seek low-risk assets like Treasuries, and that reduces interest rates. Liquidity and risk trump increased Treasury supply. (Source: Dr. Elliot Eisenberg, the Bowtie Economist).

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