Here are some rough numbers to give you an idea of the size of the U.S. bond market. These figures come from Merrill Lynch, and they represent the major categories of liquid, investment grade bonds outstanding that are not held by governments or government agencies. Funding one year of the trillion-dollar federal budget deficit will only increase the size of this market by about 8%. That's not insignificant, but it's not enough by itself to cause the value of all $13 trillion worth of bonds to change by any significant amount. All non-Treasury bonds are effectively priced off of Treasury bonds, so if T-bond prices take a nose-dive, then all bonds have to take a similar nose-dive.
By the same logic, it should not be too difficult for the Fed to execute its exit strategy if it chose to do so. The Fed currently holds about $620 billion of Agency and MBS securities. If they sold $100 billion of those securities a month that would be similar in order of magnitude terms to the amount of debt that Treasury is selling to fund this year's deficit. And their balance sheet would shrink dramatically, almost as fast as it increased last year.
And despite all the Treasury issuance this year, and despite the difficulties the bond market has had for the past year, and despite all the losses that major institutional investors have suffered, the average price of mortgage-backed securities has not changed materially year to date.
It's a very big bond market out there, and hundreds of billions and even trillions are not that hard for the market to absorb, believe it or not.