Tapering is coming. And markets know it. The mere thought that tapering of the Federal Reserve’s quantitative easing (QE) program was due in September was enough to push many markets and currencies (especially emerging markets) significantly lower. So the question arises for the occasion of the actual tapering that’s likely to begin in 2014: have markets already reacted to tapering or is there more to come?
My sense is that tapering is already priced in to some extent. If you look at how the market has reacted since the last Fed meeting, you’d seen 10-year U.S. Treasury yields back up around 2.70% from a low of 2.50% a few weeks back. I’ve also seen a few economists pull forward their expectations of tapering. To that extent, tapering starting some time in 2014 seems to be getting built into expectations. That said, don’t be surprised when markets react negatively to the official announcement. News as prominent as that, given the monetary-policy fuelled world we’ve lived in since the 2008 crisis, can take a few days to sink in. The thing to keep in mind, though, is that even though the headlines will be “TAPERING!!” the mere announcement of tapering won’t be the main event in most experts’ minds.
The statements on forward guidance will be the important part. If the tapering announcement comes with some softening in the guidance language, we are likely to see a contained market reaction to the announcement. With this, I’m thinking of a scenario where the Fed brings their employment threshold a bit lower or signals a tolerance for higher inflation before they begin tinkering with the near-zero fed funds rate. Bernanke is already laying the groundwork for this type of message. In remarks at the National Economists Club’s annual dinner on Tuesday, the outgoing Fed chairman said “Even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the [FOMC] can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.” The meaning they’ll be trying to deliver is “Yes, we’re starting to take away QE, but we’re still keeping monetary policy VERY accommodative” and that should be supportive of risk assets like equities.
And in that effort, it’s probably good that Janet Yellen was tapped as Ben Bernanke’s successor at the Fed. Yellen is widely seen as an open communicator and one who’ll continue Bernanke’s quest for transparency in how the Fed communicates its moves. The Fed has been criticized in the past year or so for not effectively communicating their intentions, and there are more than a few pundits who don’t expect the Fed to successfully end the era of U.S. quantitative easing. So it will be more important than ever that the Fed not only says the “right” thing, but says it in the “right” way.
The information in this article has been derived from sources believed to be accurate. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity.
The information in this article contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The general information it contains does not take account of any investor’s investment objectives, particular needs or financial situation, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.
Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this article.
Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided.