Time for taper tantrum II?

We assess the mood in bond markets as central banks once again start to focus on tapering quantitative-easing programmes.

Key points

• Central banks are once again talking about reducing the rate at which they will continue to buy bonds through their various quantitative easing (QE) programmes. 
• Investors appear more sanguine than during the ‘taper tantrum’ in 2013.
• Potential tapering has been better flagged this time, with central-bank messaging so far suggesting no rapid rate hike will follow on the heels of the tapering.
• Investors will continue to be more concerned about concrete details of any acceleration in the rate of tapering, persistent inflation, and the timing of actual rate rises.
• We think a diversified approach to fixed income that allows some shorting ability is prudent to navigate potentially turbulent markets.

As the tentative post-pandemic recovery continues, central banks are once again making plenty of noise about reducing the rate at which they will continue to buy bonds through their various quantitative-easing (QE) programmes.  

This new round of ‘taper talk’ is markedly different to the last one back in 2013, when the so-called ‘taper tantrum’ was greeted by significant market unease and volatility. By contrast, so far, bond investors in 2021 appear to be more sanguine. Why?

First, potential tapering has been better flagged than last time. This time round, central-bank messaging, so far, suggests the process of reducing asset purchases will be more drawn out than in 2013, and that when the tapering process does begin in earnest, there will be no rapid rise in interest rates following on its heels. Investors will continue to be more concerned about concrete details of any acceleration in the rate of tapering, and, most importantly, when the actual rate rises occur.

Trigger point Q1 2022?

The trigger for rate rises is likely to be when there is clearer visibility on employment levels, which will remain dependent on the successful transition of economies. Employment statistics are currently displaying confusing signals as economies adjust from a pre to post-Covid world, and we would anticipate greater clarity around the direction of job numbers as government support packages start to drop away.

Our expectation is that it probably won’t be until the first quarter of next year that central bankers get a clear idea on when they need to adjust monetary policy beyond simply slowing down their bond-buying programmes.

QE a more permanent tool

The authorities’ attitude to QE has hardened over recent years, and it has long since moved from being a temporary measure to a more permanent central-bank tool. This is especially the case if you consider the sheer scale of many countries’ budget deficits and the current amount of government issuance. Continuing government support for economies will be required to aid the transition to a post-Covid world, but the cost of this cannot be allowed to grow too high. Therefore, we would expect central banks to be concerned with keeping borrowing costs lower by maintaining some involvement via their QE programmes.

Inflation concerns

We anticipate that inflation will be another key concern for bond markets over the next six months. Many of the short-term factors that have driven inflation higher are likely to fall back, but it is unlikely that we will end up with inflation back within the range that we saw before the Covid crisis. Upward pressures on inflation can best be summarised as a continued adjustment to Covid by the major economies. Transportation costs are climbing, energy prices have shot up, and cyclical inflation is building.

At times in the coming weeks and months (as we saw in the first quarter of this year) we would expect markets to again be surprised by central-bank conversations about a tightening of monetary policy, but we would anticipate most related volatility to come from actual rate increases rather than tapering. We believe this backdrop underlines the importance of a diversified approach to fixed-income markets that allows for some shorting ability as the most effective way to navigate potentially turbulent markets ahead.

Authors

Paul Brain