Despite the apprehensions, we think that a Fed taper should be less of an event risk this time around, especially compared to 2013.
Last week’s anticipated Jackson Hole conference added further confirmation that the Fed aims to begin tapering asset purchases later this year.(1) Discussions of tapering often raises the memory of the 2013 taper tantrum; however, so far markets have taken this mostly in stride.
Tapering shouldn’t necessarily upset markets – after all a reduction in Fed bond purchases will coincide with less issuance from the Treasury which is simply a reversal from the Covid-related stimulus where the deficit increased and the Fed bought up the bond issuance.
If it’s not tapering itself that upsets markets, then why so much focus? When it comes to tapering, it’s more about what it represents. Beginning to reduce asset purchases is the first step in removing policy support, and the start of tapering ultimately sets up the timing for potential rate hikes. The process generally follows a timeline of The Fed talks about tapering (that’s where we are), tapers, talks about rates hikes, and then eventually hikes rates.
That said, some market participants also worry that the Fed is dead-set on tapering regardless of the state of the recovery, ignoring the latest slowdown brought on by the rapid spread of the Delta variant. Additionally, investors have the memory of 2013, when the taper announcement was unexpected, precipitating a bond selloff and roiling risk assets.
But this isn’t 2013, and this isn’t the same Fed. For a few reasons: First, The Fed’s 2013 announcement failed to separate tapering from rate hikes and left a confusing signal as to whether a stark shift towards restrictive policy was on the horizon. Now the Fed has been very careful to make this distinction stressing that tapering and rate hikes are distinct policy tools.
Second, Communication is key. The Fed learned its lesson the hard way on the importance of telegraphing moves ahead of time and has done much to provide ample notice before tapering begins, allowing markets to digest future moves.
Lastly, Expectations are crucial: In 2013, markets and the Fed were not on the same page.
The market was priced for a dovish Fed, and the “tantrum” happened because the bond market repriced to take into account rate hikes sooner than it expected.
Today, markets are on the other side of that trade, expecting at least one hike in 2022, while the Fed dots don’t imply one until 2023. The inflation trajectory is likely going to be key. More persistent inflation will keep worries live about a ‘hawkish’ Fed. On the other hand, if inflation proves transitory and markets re-price dovishly back in line with the more accommodative Fed dots, that’s likely a positive for risk assets.
Beyond any knee-jerk reactions to tapering, it is important to position investment in the context of the cycle that we are in right now. Compared with 2013, when tapering occurred when the US economy was in early stage of its recovery, this time around the Fed is discussing tapering when the economy is already in mid-cycle and probably past the peak in terms of the speed of the recovery.
This means that a mid-cycle playbook is more relevant right now. This means alpha over beta, as we see less broad-based returns in markets. In equities, it may also mean taking off some of the cyclical overweight and having a more balanced portfolio featuring more quality growth names.
1 Source: The meeting was conducted on August 26-28, 2021. Last week’s anticipated Jackson Hole conference added further confirmation that the Fed aims to begin tapering asset purchases later this year.(1) Discussions of tapering often raises the memory of the 2013 taper tantrum; however, so far markets have taken this mostly in stride.
Tapering shouldn’t necessarily upset markets – after all a reduction in Fed bond purchases will coincide with less issuance from the Treasury which is simply a reversal from the Covid-related stimulus where the deficit increased and the Fed bought up the bond issuance.
If it’s not tapering itself that upsets markets, then why so much focus? When it comes to tapering, it’s more about what it represents. Beginning to reduce asset purchases is the first step in removing policy support, and the start of tapering ultimately sets up the timing for potential rate hikes. The process generally follows a timeline of The Fed talks about tapering (that’s where we are), tapers, talks about rates hikes, and then eventually hikes rates.
That said, some market participants also worry that the Fed is dead-set on tapering regardless of the state of the recovery, ignoring the latest slowdown brought on by the rapid spread of the Delta variant. Additionally, investors have the memory of 2013, when the taper announcement was unexpected, precipitating a bond selloff and roiling risk assets.
But this isn’t 2013, and this isn’t the same Fed. For a few reasons: First, The Fed’s 2013 announcement failed to separate tapering from rate hikes and left a confusing signal as to whether a stark shift towards restrictive policy was on the horizon. Now the Fed has been very careful to make this distinction stressing that tapering and rate hikes are distinct policy tools.
Second, Communication is key. The Fed learned its lesson the hard way on the importance of telegraphing moves ahead of time and has done much to provide ample notice before tapering begins, allowing markets to digest future moves.
Lastly, Expectations are crucial: In 2013, markets and the Fed were not on the same page.
The market was priced for a dovish Fed, and the “tantrum” happened because the bond market repriced to take into account rate hikes sooner than it expected.
Today, markets are on the other side of that trade, expecting at least one hike in 2022, while the Fed dots don’t imply one until 2023. The inflation trajectory is likely going to be key. More persistent inflation will keep worries live about a ‘hawkish’ Fed. On the other hand, if inflation proves transitory and markets re-price dovishly back in line with the more accommodative Fed dots, that’s likely a positive for risk assets.
Beyond any knee-jerk reactions to tapering, it is important to position investment in the context of the cycle that we are in right now. Compared with 2013, when tapering occurred when the US economy was in early stage of its recovery, this time around the Fed is discussing tapering when the economy is already in mid-cycle and probably past the peak in terms of the speed of the recovery.
This means that a mid-cycle playbook is more relevant right now. This means alpha over beta, as we see less broad-based returns in markets. In equities, it may also mean taking off some of the cyclical overweight and having a more balanced portfolio featuring more quality growth names.
1 Source: The meeting was conducted on August 26-28, 2021.
Tapering shouldn’t necessarily upset markets – after all a reduction in Fed bond purchases will coincide with less issuance from the Treasury which is simply a reversal from the Covid-related stimulus where the deficit increased and the Fed bought up the bond issuance.
If it’s not tapering itself that upsets markets, then why so much focus? When it comes to tapering, it’s more about what it represents. Beginning to reduce asset purchases is the first step in removing policy support, and the start of tapering ultimately sets up the timing for potential rate hikes. The process generally follows a timeline of The Fed talks about tapering (that’s where we are), tapers, talks about rates hikes, and then eventually hikes rates.
That said, some market participants also worry that the Fed is dead-set on tapering regardless of the state of the recovery, ignoring the latest slowdown brought on by the rapid spread of the Delta variant. Additionally, investors have the memory of 2013, when the taper announcement was unexpected, precipitating a bond selloff and roiling risk assets.
But this isn’t 2013, and this isn’t the same Fed. For a few reasons: First, The Fed’s 2013 announcement failed to separate tapering from rate hikes and left a confusing signal as to whether a stark shift towards restrictive policy was on the horizon. Now the Fed has been very careful to make this distinction stressing that tapering and rate hikes are distinct policy tools.
Second, Communication is key. The Fed learned its lesson the hard way on the importance of telegraphing moves ahead of time and has done much to provide ample notice before tapering begins, allowing markets to digest future moves.
Lastly, Expectations are crucial: In 2013, markets and the Fed were not on the same page.
The market was priced for a dovish Fed, and the “tantrum” happened because the bond market repriced to take into account rate hikes sooner than it expected.
Today, markets are on the other side of that trade, expecting at least one hike in 2022, while the Fed dots don’t imply one until 2023. The inflation trajectory is likely going to be key. More persistent inflation will keep worries live about a ‘hawkish’ Fed. On the other hand, if inflation proves transitory and markets re-price dovishly back in line with the more accommodative Fed dots, that’s likely a positive for risk assets.
Beyond any knee-jerk reactions to tapering, it is important to position investment in the context of the cycle that we are in right now. Compared with 2013, when tapering occurred when the US economy was in early stage of its recovery, this time around the Fed is discussing tapering when the economy is already in mid-cycle and probably past the peak in terms of the speed of the recovery.
This means that a mid-cycle playbook is more relevant right now. This means alpha over beta, as we see less broad-based returns in markets. In equities, it may also mean taking off some of the cyclical overweight and having a more balanced portfolio featuring more quality growth names.
1 Source: The meeting was conducted on August 26-28, 2021. Last week’s anticipated Jackson Hole conference added further confirmation that the Fed aims to begin tapering asset purchases later this year.(1) Discussions of tapering often raises the memory of the 2013 taper tantrum; however, so far markets have taken this mostly in stride.
Tapering shouldn’t necessarily upset markets – after all a reduction in Fed bond purchases will coincide with less issuance from the Treasury which is simply a reversal from the Covid-related stimulus where the deficit increased and the Fed bought up the bond issuance.
If it’s not tapering itself that upsets markets, then why so much focus? When it comes to tapering, it’s more about what it represents. Beginning to reduce asset purchases is the first step in removing policy support, and the start of tapering ultimately sets up the timing for potential rate hikes. The process generally follows a timeline of The Fed talks about tapering (that’s where we are), tapers, talks about rates hikes, and then eventually hikes rates.
That said, some market participants also worry that the Fed is dead-set on tapering regardless of the state of the recovery, ignoring the latest slowdown brought on by the rapid spread of the Delta variant. Additionally, investors have the memory of 2013, when the taper announcement was unexpected, precipitating a bond selloff and roiling risk assets.
But this isn’t 2013, and this isn’t the same Fed. For a few reasons: First, The Fed’s 2013 announcement failed to separate tapering from rate hikes and left a confusing signal as to whether a stark shift towards restrictive policy was on the horizon. Now the Fed has been very careful to make this distinction stressing that tapering and rate hikes are distinct policy tools.
Second, Communication is key. The Fed learned its lesson the hard way on the importance of telegraphing moves ahead of time and has done much to provide ample notice before tapering begins, allowing markets to digest future moves.
Lastly, Expectations are crucial: In 2013, markets and the Fed were not on the same page.
The market was priced for a dovish Fed, and the “tantrum” happened because the bond market repriced to take into account rate hikes sooner than it expected.
Today, markets are on the other side of that trade, expecting at least one hike in 2022, while the Fed dots don’t imply one until 2023. The inflation trajectory is likely going to be key. More persistent inflation will keep worries live about a ‘hawkish’ Fed. On the other hand, if inflation proves transitory and markets re-price dovishly back in line with the more accommodative Fed dots, that’s likely a positive for risk assets.
Beyond any knee-jerk reactions to tapering, it is important to position investment in the context of the cycle that we are in right now. Compared with 2013, when tapering occurred when the US economy was in early stage of its recovery, this time around the Fed is discussing tapering when the economy is already in mid-cycle and probably past the peak in terms of the speed of the recovery.
This means that a mid-cycle playbook is more relevant right now. This means alpha over beta, as we see less broad-based returns in markets. In equities, it may also mean taking off some of the cyclical overweight and having a more balanced portfolio featuring more quality growth names.
1 Source: The meeting was conducted on August 26-28, 2021.
After one and half years of strong growth recovery, monetary policy in the U.S. may be soon making the first step toward policy normalization in the coming months. At the just-concluded Jackson Hole meeting of global central bankers, Powell provided further confirmation to markets that the Fed aims to begin tapering its asset purchases later this year. We expect an official announcement and timetable in November and tapering to formally begin in December 2021. We expect the Fed to reduce monthly purchase down to 0, from USD120bn currently, in 9-12 months.
How will the market react to the taper announcement? Many investors may remember that in 2013 Bernanke’s announcement caused a “Taper tantrum”– US treasury yields spiked and equity markets declined. In our view, it’s not tapering in and of itself (i.e., the reduction of purchase) that caused the market volatility, instead, it was how tapering was communicated and understood by markets. And this time around, the Fed has been far more deliberate and careful in its communications with markets, so tapering should be less of an event risk. We can see this in three aspects.
1) Tapering and “rate hikes” as two different policy tools. The Fed’s 2013 announcement1 failed to separate tapering from rate hikes and left a confusing signal as to whether a stark shift towards restrictive policy was on the horizon. This time, Powell has been very careful to make this distinction; repeatedly stressing that tapering and rate hikes are distinct policy tools, and that a different set of criteria – which will be communicated in due course – will be used to evaluate when rate hikes will be appropriate.
2) Ample advance notice. The Fed has done much to provide ample notice before tapering begins, allowing markets to digest future moves. Although the growth outlook is not without some downside risks, broadly the market sentiment on growth has not deteriorated. If this more positive sentiment carries into November, the tapering announcement should not come as a negative surprise. We expect that the Fed will be preparing the market in an equally deliberate fashion when the time comes for rate hikes. The sequence to remember is “talking about tapering”, “tapering”, “talking about rate hikes” then ”rate hikes”.
3) Markets are more aligned with the Fed. In 2013, markets and the Fed were far apart, whereas today they are closer. In 2013 the market was priced for a dovish Fed, and the “tantrum” happened because Bernanke delivered a big surprise. Today, the gap is smaller. While this isn’t the full picture when it comes to expectations for the entire rate hike cycle – in particular the market-implied terminal rate continues to be much lower than the Fed’s own projection – at least when it comes to the start date the market isn’t complacent. The inflation trajectory will matter for the start of rate hikes. If inflation stays elevated, the market may continue to price the “early hike”. But if inflation turns around next year, the market will be able to push back rate hikes, which can give a small boost to risk assets.
Thus, for the above three reasons – and although there are still uncertainties – we think the market reaction to Fed tapering will be more benign this time around. So how should investors position? To answer this question, it is important to bear in mind that the U.S. economy is now in mid-cycle in terms of its recovery. In fact, this is a major difference compared with 2013, when the tapering announcement and implementation both took place during the early phase of the recovery. So beyond the event risk, a simple comparison with the post-tapering market performance in 2013 is not particularly valuable, as the economic backdrop is different now.
In our view the more useful reference for investing is the mid-cycle playbook (see our previous report here). There are some simple rules to remember. First, in mid-cycle there is less broad-based upside in markets, so we favor the pursuit of alpha over beta, through careful stock selection and active management. Second, in mid-cycle, earning growth tends to normalize toward trend level, meaning that cyclical sector earning could see deceleration after a strong pickup in the early part of the cycle. The market tends to favor quality growth – and we like technology and healthcare. The more elevated level of inflation in this cycle may diminish some of the attraction of fixed income – and indeed we would recommend looking at alternative assets such as real estate for income in a more inflationary environment.
In our view, the combination of a (hopefully) less eventful start to tapering and the mid-cycle backdrop for the U.S. market is a positive for Asia, as evidenced by benign market performance since Jackson Hole. If this calm carries over into the actual tapering announcement, then Asia may be able to avoid a repeat of the large swings and drawdown we saw in 2013. We continue to expect U.S. yields to rise on the back of strong growth, the Fed cutting back its purchases adds one more catalyst to higher yields. While this could create near-term dollar strength, a gradual grind higher would not likely put undue pressure on Asian markets.
Our macro-stability indicators have broadly been holding up. A benign taper may create a more favorable environment to own Asia FX for carry, particularly vs. low yielders (JPY, EUR). We like CNH, SGD and IDR. On the equity side, our investment views on Asia depend on how the growth recovery will evolve from here. The ongoing impact of Delta will likely further set back Asia’s domestic demand recovery, particularly in Malaysia, Indonesia, Thailand, Vietnam. Although some will move past the worst in the coming weeks and months, low vaccination rates mean the buffer is thin when it comes to resiliency in the face of future COVID waves. For now, we prefer economies with export tailwinds and effective COVID containment such as China (A-shares), Korea and Taiwan (in Taiwan, export strength should more than compensate for COVID-related weakness). On the fixed income side, downside risks to domestic growth may create a more favorable environment to own Asia bonds. We like China, Indonesia, Thailand.
1Federal Reserve as of May 22, 2013. https://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm
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