Bank of America: Washington version of "fiscal policy" may not stir up much of a storm, interest rate market impact negligible.

Bank of America strategists pointed out that the nominee for Federal Reserve Chairman, Kevin Warsh, called for a new agreement with the Treasury Department. However, given that the two institutions have maintained close collaboration, this move is unlikely to have a substantial impact on bond prices. Warsh proposed reassessing the 1951 "Treasury-Federal Reserve Agreement," which had significantly restricted the Fed's participation in the bond market. Over the past decade, ongoing asset purchases have expanded the Fed's balance sheet to $6.6 trillion. Bank of America strategists, including Mark Cabana and Katie Craig, believe that the proposal is vague in definition, and most of its contents already reflect current operations. In a note published on Thursday, they stated that what could potentially have a significant market impact is a reduction in Treasury long-term bond issuance or the Fed implementing an interest rate peg policy, although the latter is less likely. The strategists wrote, "Other agreement measures are likely to have limited impact. We believe the new 'agreement' will have minimal impact on rate markets." The original agreement ended wartime interest rate controls and reinforced central bank independence. Bank of America strategists stated that the current discussions focus on more technical issues, such as the Fed's reinvestment of maturing bonds and portfolio management. More aggressive measures, such as formal limits on bond purchase programs or setting a long-term yield cap, may be difficult to incorporate into a new agreement. Bank of America believes that the market has largely digested most of the expected adjustments: - The Fed will allow mortgage-backed securities to naturally shrink from its balance sheet, with government-controlled Fannie Mae and Freddie Mac taking over. - The Fed will buy Treasury securities through reserve management operations, with the Treasury issuing such notes to replace maturing debt. - The weighted average maturity of the Fed's balance sheet holdings may shorten as they roll over long-term bonds, a process that could accelerate. The impact on the market will depend on adjustments to the Treasury's issuance pace. In conclusion, the strategists stated that unless the agreement breaks beyond the above categories, "our conclusion is: the new agreement may have limited impact on rates."