Tapering, Disappointing Data, and Lack of Global Growth

IN THIS PUBLICATION:

• If stimulus is reduced, we'd expect inflation expectations to fall, driving yields lower and not higher, contrary to 2013’s Taper Tantrum.
• Tapering is less likely than what the market implies as the US economy continues to show signs of weakness (especially in the labor market).
• Several indicators are hinting at the reflation narrative being little more than a mirage.

Don't Expect a Repeat of 2013

Ahead of the next Fed meeting scheduled for September 22^nd, attention has turned to the possibility of a taper announcement.

• When the Fed announced a reduction of their QE bond-buying program in 2013, bonds dramatically sold off (and yields surged).

Dubbed the ‘taper tantrum’, 2013 is seen as the blueprint for a potential taper announcement in the coming months. But investors may be wrongfooted if they think higher yields are inevitable.

• In 2013, both investors and the Fed believed the economy had recovered from the lows of the 2008 Financial Crisis and that it was primed for take-off. This justified higher yields.
• With investors believing equities mirrored the health of the economy, and the US stock market continuing to rally despite higher yields, confirmation that the economy was strong was set in stone.

Whilst rising yields didn’t last long (a testament to how the economy had not, in fact, recovered), thankfully, there is no longer widespread belief that the stock market is representative of the health of the economy.

We thus need to turn away from the stock market and towards inflation expectations (deep dive here).

• Before the 2013 taper, inflation expectations were at the same level as they are today.
• In 2013, however, they had been running higher than 2% for a while before falling during the taper tantrum (whilst nominal yields increased).

• During the next seven years after the Taper Tantrum, the 2% level for inflation expectations struggled to materialize for any extended period of time.
• Since the pandemic, the pick-up in inflation expectations has been the key driver of higher nominal rates.

Inflation may be rising at a faster pace today, but it has a much weaker foothold when compared to 2013. If today’s stimulus is reduced, we would expect inflation expectations to fall, driving yields lower (and not higher, like in 2013) given that so much of the rise in inflation (and thus, of nominal yields) is dependent on the continuation of the current liquidity bonanza.

That said, we believe tapering is not likely as we see economic data rolling over.