FED Tapering

In a much-anticipated speech on 27Aug 2021, Federal Reserve chairman Jerome Powell indicated that the central bank may begin reducing its monthly bond purchases as early as this year. The market participants have been anticipating this announcement for many months now. What exactly is Fed Tapering and will we see a repeat of 2013 Taper Tantrum?

What has the Fed been doing?

When the economy undergoes recession or financial crisis (2008 Global Financial Crisis and the recent 2020 Covid-19 pandemic), the banks are hesitant to make loans as they fear them turning to Non-Performing Loans (NPL). In such situations, the central banks may step in and buy bonds through the Open Market Operations to induce liquidity into the economy. This increases the money supply in the economy and lowers the interest rate as it bids up the bonds. With the extra liquidity and low-interest rate environment, the banks will have to provide loans to businesses which then circulated the money into the broader economy.

To save the market from spiralling into a full-blown financial crisis, the Fed has been buying over 100 billion of Treasury Securities and Agency mortgage-backed securities every month since the start of the pandemic in the US. The Fed balance sheet has since ballooned from $4.7 trillion to more than $8 trillion (as of Aug).

Source: https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

What is tapering and its impact on the financial markets?

Tapering is the process by which the central bank reduces the rate at which new assets are accumulating on its balance sheet. Upon completion of tapering, the central bank may decide to proceed with unwinding the balance sheet to remove the monetary stimulus gradually. 

In May 2013, then-Fed Chair Ben Bernanke made the first indication that tapering was on the horizon, setting off a market reaction aka “Taper Tantrum”. As with any demand reduction, bond investors responded by selling bonds in anticipation of future decline in price, resulting to a spike in treasury and bond yield. It led to higher interest and mortgage rates, capital outflows, and an eventual temporary decline in the stock market in mid-2013.  

Will the history of a Post Taper Tantrum happen again?

From the summary of FOMC minutes, we can come to the conclusion of the following:

  • The Fed has not stated explicitly the timeline for tapering. Though we can expect it to happen this year.
  • The tapering will precede any increase in its target for short-term interest rates.
  • The economy must make considerable progression before they start tapering and rising rates.
  • Despite the recovery, the employment level remains below the pre-pandemic condition, suggesting more time is required.

Unlike the 2013 tapering when Ben Bernanke made the announcement abruptly, the market has been more ready and may have “priced in” the tapering effect this time. The strong consensus of the New York Fed’s survey showed that market participants were already expecting tapering to begin in early 2022 even before the FOMC meeting

We believe that the equity market is in the mid-cycle environment and the earnings fundamentals are likely to play a larger role in the market performance than the macro liquidity. With that being said, some corrections along the way might be inevitable as the equity market becomes over-extended and continues hitting all-time highs.

In case you missed our Q32021 High Impact ideas, do check them out at [https://fundsinsights.uobkayhian.com/2021/08/18/q3-high-impact-idea-property/].

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: