Tapering not a problem after all? Mmm... just don't ask the casualties of 2013...

 

ref :- "Tide of US Debt Set to Recede, Countering Effect of Fed Taper", Bloomberg Economics

ref :- "Reduction in Fed's Asset Purchases Might Not Spark "Taper Tantrum", Wall St. Journal, The Outlook

We have to confess that there has always been a deeply unsavvy and naïve corner of our minds that has struggled to fully comprehend taper tantrum(s). At one level of course it's easy enough to see how they start, it's a simple matter of supply and demand. If the Fed, previously a massive absorber of available bonds and notes in its strategy to suppress yields, decides to reduce the amount of purchases it intends to make, it is not too simplistic to suggest that the extra supply of assets will lower prices... and thereby send yields higher.

But if the Fed's move is undertaken for legitimate and sensible reasons, to guard against inflation issues for example (which would themselves damage bonds markets in the longer term), and the Fed's intention and rationale was well-communicated, is it reasonable to expect the sort of chaos that we saw during the great Taper Tantrum of 2013? 

On that infamous occasion, communication (or lack of it) was definitely the detonator that sparked it all off and 10yr bond yields rose nearly 150 bp in a little over four months. It was as if investors had been caught totally by surprise by the Fed's more hawkish turn. Of course, the speed and severity of the move as investors bailed out was hugely exacerbated by herd mentality and particularly by a chronic lack of market liquidity in times of stress. Make no mistake, those problems still exist so the possibility of sharp adverse moves remain, but as far as lack of communication goes... well, let's just say that lessons were learnt from that unhappy time.

Actually, with the US 10yr yield back below 1.20% one wouldn't believe that there's too much taper anxiety knocking about. But that may be more about safe-haven seeking and a different anxiety - that the global upsurge in the Delta Covid variant will significantly damage ambitious growth projections. There's plenty of nervous talk about tapering though, and maybe current market levels are indicative of a more successful communication strategy on behalf of the Fed. We'll find out soon, maybe as early as tomorrow when a plan for asset-purchase reduction should be announced. Nothing immediate, but November's the favourite date for the Fed to make a start.

We've been struck by the number of recent articles taking a more relaxed view on the subject. The general narrative since the onset of the pandemic has been all about massive stimulus programmes funded by huge issuance of Treasury paper (already at sky-high levels after Trump's tax giveaways), much of it hoovered up by the Fed in order to keep yields down. But the Bloomberg piece argues in essence that as we move into 2022, new revenue streams will reduce the amount the Treasury is required to borrow which will at make up for the smaller amounts of government debt likely to be purchased by the Fed.

The WSJ piece looks a little wider, and tells us that bond yields over time are not affected so much by the monthly pace of asset purchases as by the total size of the Fed's purchases in the future. "Once Fed officials specify where the portfolio is headed - something they haven't yet done - it shouldn't matter for yields if the Fed buys bonds all at once or a little bit at a time, as long as the total amount is in line with market expectations". Ah, it's that communication thing again.

The current situation also differs from that of 2013 in two key ways that argue for a more reasoned response to any Fed announcement. Back then, it was the Fed's statement that bond purchases would eventually end that really rocked investors who thought they would continue indefinitely (why?). Now, no one expects the Fed to keep buying without an end in sight: "The market has seen the Fed stop once and expects it to stop again". Added to which, in 2013 investors automatically assumed that tapering bond purchases also meant that rises in interest rates were imminent. Today's Fed has made clear that it views bond purchases and low rates as two separate tools, albeit with the same goal in mind. According to Jean Boivin of Blackrock Investment Institute: "If the Fed manages to divorce the slowing of asset purchases from its intended path on policy rates, I don't think we need to expect a tantrum".

Everybody has their own expectations and how they differ from Fed statements will determine investor reactions. Since not everybody can be right, it's only sensible to expect those reactions might be quite sharp in the short-term, especially as those issues of market dynamics are still very much in play. But it's reassuring to hear that some good judges think that the response might, just might, be a lot more measured than the one we saw in 2013. Then again, perhaps that's naïve thinking once again and a triumph of hope over experience.