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Matthew C Klein

Will Mortgage Bonds Enter the Vortex?

An explanation of the "convexity vortex."

In my previous post, I argued that bondholders will probably be able to tolerate any "tapering" of the Federal Reserve's asset purchases so long as they aren't using much leverage and are willing to hold to maturity. After all, the Fed has been bidding up financial asset prices to stimulate the economy, and I doubt financial policymakers would consciously choose to inflict substantial losses on savers.

That said, the prices of bonds could get a lot more volatile over the next few years. One possible scenario: the Fed starts tapering its asset purchase program only to observe large increases in interest rates, thereby leading to an increase in stimulus. This sort of start-stop (or slow-down, speed-up) behavior would fit with the pattern we have seen over the past few years with QE1 and QE2.