Taper Tantrum or Taper Tranquility?
In the past few weeks, investors have turned their attention to the messaging from the Federal Reserve regarding discussions of reducing bond-purchase programs.
So, will there be another taper tantrum or taper tranquility?
Back in 2013, the Fed talked about reducing its accommodative monetary policies. Bond investors were spooked by the message from the Fed, sending the markets into a sharp sell-off. Interest rates skyrocketed, emerging markets collapsed, high yield bond prices tumbled, and market volatility exploded.
Although investors have become overly preoccupied with the Fed announcing its tapering, the opposite of this is developing.
For instance, 10-year US Treasury yields have fallen from their recent Mar 2021 high of 1.765% to a recent low of 1.129% (8/5/21). Long-term rates may have stopped rising sharply higher, in part because investors do not expect the Fed will lift short-term rates too much in the years ahead. Also, the recent sharp rise in consumer prices is driven by temporary factors, including bottlenecks in production as the economy fully reopens. The inflationary pressures may very well be transitory, as the Fed suggests.
One of the higher-risk fixed-income assets, high yield bonds as represented by JNK and HYG ETFs, have also held up well this year. From its respective 7/19/21 lows, there appear to be higher-low patterns developing.
The emerging-markets stocks may have come under pressure this year, more because of the Chinese government crackdown on Chinese technology names rather than taper fears. Nonetheless, the Emerging Markets ETF (EEM) is flat for the year despite the sharp sell-offs in Chinese technology ADRs.
If a taper tantrum is indeed developing, speculative markets such as JNK, HYG, and EEM should come under severe selling pressure as global investors de-risk their portfolios.
SPX implied volatility or the VIX Index also remains relatively subdued, hovering near the lows for the year along the mid-teens. Below 13.5-14.5 may signal VIX retesting its all-time lows of 9.39-9.5, possibly triggering the final melt-up phase to the structural bull stock market rally.
So, why is the stock and bond market suggesting tapering is not a concern?
Like 2013, the Fed began signaling during early spring that it will soon taper, messaging that it will move up the timeframe to reduce its monthly bond-purchasing programs. However, the backdrop was quite different back then, partly because the Fed and investors had no clues as to what to expect. The central bank has never implemented such a large-scale asset purchase program, commonly referred to as quantitative easing or QE. At the height of the asset purchase program, the QE program soon evolved to QE infinity, and beyond!
In 2013, many investors were unsure as to how or when the massive asset purchase programs would end. When the Fed finally announced the bond-buying program would not sustain forever, many investors were shocked by the news they quickly unloaded their bonds.
Today, although investors are still worried about the Fed tapering, the market is not responding to the taper news has many puzzled.
The simple explanation may rest with the fact that unlike the last time around (2013), the end to the Fed asset purchases is less frightening to investors today. Investors have already experienced the Fed reducing the size of its balance sheet during 2018 and 2019. The unwinding of the assets did not trigger a taper tantrum. Another reason may be investors believe the Fed knows what to do this time. They will not repeat the same mistake they made in 2013. The Fed will do a better job of preparing investors for tapering than the prior cycle.
Despite the current tranquility, perhaps the Fed old road map may not work well in the new post-pandemic world. Or will the massive fiscal stimulus ease any of the side effects from the Fed tapering program? Will the ongoing pandemic create lasting dislocations in employment rate, consumption, spending, investing, and global economic activities?
The Fed and central banks will do whatever it takes to avoid repeating the 2013 taper tantrum debacle. However, investing remains unpredictable. Investing is more of a marathon than a sprint. Investors must be well-prepared, resilient, disciplined, and focus to complete the race. We recommend investors pay close attention to the above-leading markets/indicators for signs of changes to the financial marketplace.