The Fed officially tapered its quantitative easing (QE) bond purchases today, and far from triggering a tantrum, it ended up being a giant snooze. Instead of being rocked by the news, the S&P 500 flipped from slightly negative on the day before the announcement to close up 0.7%.[i] The 10-year US Treasury yield rose all of 4 basis points on the day, from 1.55% to 1.59%.[ii] Most commentary on the move was laced with sleep aid, with the notion of a “taper tantrum”—prevalent mere months ago—largely disappearing down George Orwell’s famous memory hole. About all pundits could conjure up in the way of angst were questions about when the Fed would hike rates. Let this be a lesson: Markets pre-price widely expected events, including monetary policy decisions, which don’t have a preset market impact.
We don’t often give central bankers kudos, but we would like to start by presenting Fed head Jerome Powell and friends the (ironically named) Mark Carney Award for Acting in Accordance with Forward Guidance, rather than saying A but doing B at the last minute.[iii] The minutes from the Fed’s July meeting revealed monetary policymakers “judged that it could be appropriate to start reducing the pace of asset purchases this year.”[iv] In his late-August (virtual) address at the (virtual) Jackson Hole central banker confab, Powell reiterated that stance and said he believed inflation had made enough “substantial further progress” to warrant tapering. Minutes from September’s meeting teed up this month as Taper Decision Day and outlined a potential path for “monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS).”[v] That is precisely what the Fed announced today, with the reduction beginning this month. The policy statement left some wiggle room to change course in the future if economic data veer unexpectedly,[vi] but otherwise, QE is set to conclude in June.
And that was that! No fireworks. No big market swings. The tantrum pundits wrote about repeatedly over the summer just hasn’t happened. The S&P 500 is now up 5.1% since those July meeting minutes were released in mid-August.[vii] 10-year Treasury yields are up 33 basis points.[viii] That is even smaller than its move during 2013’s taper talk, which we view as the alleged tantrum that wasn’t. In our view, this echoes the general non-reactions to the Bank of England’s (BoE’s) decision to halt QE outright, the European Central Bank’s taper that chief Christine Lagarde swore wasn’t a taper, the Bank of Canada’s quiet tapering for most of this year, and the Reserve Bank of Australia’s abandonment of its “yield curve control” policy, which set official targets for 3-year yields. None of these moves caused a big ruckus in stocks.
We think this speaks volumes about how markets work. All the hype about 2013’s alleged taper tantrum, warranted or not, set expectations globally for a tantrum this time around. But markets have a long history of pre-pricing popular expectations, then doing something different. All those taper tantrum fears were self-tapering, evidently.
In a perfect world, people would learn the lesson and stop fearing the Fed’s every move toward “tightening,” which we use scare quotes for because ending QE is the opposite of tightening. (More on that here.) But given the shifting focus to rate hikes, we rather doubt it. On the bright side, the heightened focus on a policy lever the Fed won’t pull for several months at least means it, too, will likely be fresh out of surprise power whenever the time comes. We wouldn’t sweat it.
In our view, this whole central bank obsession is misguided. Monetary policy is but one variable affecting the economy, which is far too complex for the Fed to control by tweaking one rate here and another rate there. The US economy is too messy and decentralized, which is a good thing—albeit a factor in recent supply chain disruptions. Moreover, no set level or direction for interest rates is inherently good or bad for the economy or stocks. The appropriateness of any policy depends on prevailing conditions at the time, including the yield curve. The thing we think everyone misses about QE is that it flattens the curve, while tapering and ending it enable the curve to steepen by removing some downward pressure on long rates—hence we see today’s move as an incremental positive. Aggressive rate hikes down the road could invert the yield curve, but there is no indication that will be a risk any time soon.
The good news is, you don’t need to identify any of this in advance. Yield curves aren’t timing tools. The global yield curve’s extremely shallow inversion in 2019 didn’t cause a bear market or recession. Other, deeper inversions have presaged tough times, but they weren’t triggers—just warning signs. The allegedly flattening sections of the curve that pundits have flagged more recently—be it the 2-year – 10-year spread or 5-year – 30 year span—are largely meaningless. Banks get most of their financing at overnight rates, not via 2-year and 5-year time deposits.
We suggest looking at the bigger picture. The economy is still growing despite the supply chain headaches and other headwinds, and central banks haven’t done anything to make that less likely over the foreseeable future. With sentiment still hung up on the mere possibility that these institutions could eventually upset the applecart, expectations are staying in check, likely leaving plenty of room in this bull market’s wall of worry.
[i] Source: FactSet, as of 11/3/2021. S&P 500 price return at close, 11/3/2021.
[ii] Source: FactSet, as of 11/3/2021.
[iii] Carney, you might remember, famously set 7% unemployment as the Bank of England’s threshold for raising rates in 2013, then did a massive U-turn when unemployment hit that level much sooner than expected. All the mixed messaging led one Member of Parliament to liken him to an “unreliable boyfriend,” a tagline pundits repeated with glee as the BoE continued emitting mixed signals for years.
[iv] “Minutes of the Federal Open Market Committee, July 27-28, 2021,” Federal Reserve, 8/18/2021.
[v] “Minutes of the Federal Open Market Committee, September 21-22, 2021,” Federal Reserve, 10/13/2021.
[vi] A way of heading off a constant fear of policymakers: That folks somehow get the notion that monetary policy decisions are “on autopilot.”
[vii] See Note i. S&P 500 total return, 8/17/2021 – 11/3/2021.
[viii] Ibid. 10-year US Treasury yield, 8/17/2021 – 11/3/2021.
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