The US Federal Reserve is pushing ahead on its path to the normalising monetary policy this year, but so far markets aren’t panicking.
It’s led some analysts to question why we aren’t seeing a “taper tantrum” similar to the events of 2013.
In a note to clients, PIMCO managing director Richard Clarida has outlined two reasons why this time is different.
He said that while the Fed will steadily reduce asset purchases, it still has a couple of moves up its sleeve to help smooth the process.
And also, the market’s expectations around future bond market moves are more stable now.
That’s different from May 2013, when then-US Federal Reserve Chair Ben Bernanke testified before Congress and indicated that the Fed would re-assess its asset purchase program.
At the time, the Fed was buying $US45 of treasuries and $US40 billion of mortgage-backed securities (MBS) per month.
Bernanke caught the market off-guard — US bond yields spiked from 1.94% to above 3% later in 2013, and global bond markets followed suit.
Fast forward to May 2017, when the monthly minutes from the Fed showed that it was planning to reduce asset purchases later this year.
Clarida notes that instead of another “tantrum”, US bond yields actually fell on the news. Yields climbed slightly in June but remained below their 2017 highs, and US 10-year notes have since fallen back below 2.3%:
“Going into Ben Bernanke’s testimony in May 2013, the OIS (overnight index swap) interest rate forward curve was pricing in an expected Fed policy rate of about 2.5% by year-end 2019,” Clarida said.
It subsequently spiked to 4% by December that year. In fact, Clarida noted that the spike in the future Fed funds rate was higher than the rise in 10-year bond yields during that time.
Market expectations have subsequently changed. Clarida said right now, even after 4 rate increases and direct plans to reduce asset purchases, the forward pricing for interest rates by the end of 2019 still only fluctuates around the 2% mark.
He also said that details in the addendum to the minutes from the Fed’s June 2017 meeting show how the asset purchase program will be smoothed out.
“Under the plan laid out in the Addendum, the Fed will announce caps on the maximum amounts of Treasury and MBS securities that will be allowed to roll off each month,” Clarida said.
So although the purchases will steadily be reduced, the Fed will still be very involved in buying both treasuries and mortgage backed securities.
Clarida said that the caps on MBS will likely be removed within 12 months once purchases start to reduce (which is likely to commence in September). However, he expects the Fed to stay active in the treasuries market into the next decade.
While there’s an added sense of calm these days in US bond markets, Clarida said that the coast isn’t yet clear.
If forward re-pricing changes from its current level or the Fed implements a more aggressive agenda in normalising policy, the next “taper tantrum” could follow.
He added that US bonds are only part of the picture, and the US market is still influenced by the moves of other central banks.
That’s been evidenced in July as markets reacted to a shift in tone among global central banks to a more bullish stance.
It all adds up to an intriguing picture as the respective central banks of Japan and Europe make their interest rate announcements later today.
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