When your crystal ball doesn’t work so well – talking taper again!

In my July article, which was based on reasonable analyses and deductions, I predicted that the U.S. Federal Reserve Bank (the Fed) would likely start “tapering” in March 2022. Sadly, I was completely wrong. In my defence, however, I suggested then that the timeline could be brought forward based on incoming labour market and inflation data, which incidentally have surpassed market expectations since. The unemployment rate, for example, was at 5.9% in June but declined to 4.6% in October while the Fed’s preferred gauge of inflation, core personal consumption expenditure (core PCE), continued to outpace the Fed’s 2% target moving from 3.59% in June to 3.64% in September. Additionally, consumer price inflation remained elevated at decades high of 5.4% in September. So naturally, the Fed concluded that conditions to commence tapering have been met and will therefore begin to reduce its monthly pace of bond purchases, currently at $120 billion, by $15 billion per month starting in November. If this pace is sustained, the Fed will phase out the purchases entirely by next June.

Unsurprisingly, market reaction to the announcement of tapering has not been chaotic and has been consistent with my expressed view at the time that since ‘tapering’ was not a novel event as it was in 2013 markets would display a lot more discipline and maturity. Perhaps what has been surprising however is how well markets have responded post the tapering announcement. For instance, the benchmark U.S. 10-year treasury yield has fallen by 16bps to 1.44% as of November 9^th while the S&P stock index gained 1.5% to reach a new record high on November 8^th. So, with the tapering announcement basically being a non-event for markets, the question now being contemplated is what happens next.

The withdrawal of last year's emergency support was widely expected because it was telegraphed by policymakers in advance, but, naturally, markets have been trying to figure out what comes next. With inflation running hot globally and some other central banks moving toward monetary tightening, the worry was that the Fed might be forced to raise rates sooner rather than later.

The Fed doesn’t appear to be in any rush to commence raising rates despite an earlier start to tapering and will try to delay lift off until 2023. In fact, the policy statement released after the meeting last Wednesday and Fed Chairman Jerome Powell’s post-meeting press conference stressed that policymakers still expect recent elevated inflation to moderate and will need to see further labour market improvement before raising rates. Those messages helped to calm fears about an abrupt tightening of monetary policy which could be catastrophic for both bond and equity markets. So, in my view, a favourable environment for investing should persist for at least the next six months unless the Fed becomes overly concerned about incoming inflation data and is forced to tighten sooner than planned. However, should the Fed be forced to act more aggressively than planned, investors can take comfort in the knowledge that history has demonstrated that market hysteria doesn’t last for very long and often offers very attractive investment opportunities.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm

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