Minutes minutiae: Fed inching closer to the exit
Last week, we received the minutes of the Federal Open Market Committee (FOMC) meeting held at the end of July. Tapering was the word of the day. A reduction in the pace of asset purchases is now overwhelmingly expected by the year’s end. When thinking about the risks to global markets posed by tapering, we believe it is worth remembering three things.
First, never has a pending policy change been discussed so much, by so many, for so few insights. Market shocks tend not to be driven by things that are almost entirely predictable.
Second, aggressive tapering happened last year, and nobody really noticed. In the first three months of the COVID-19 crisis, from March to May 2020, the Federal Reserve (Fed) bought $1.6 trillion of Treasuries. In the subsequent 14 months, it has bought just over $1.1 trillion. The pace of asset purchases has slowed down by 85% since those early days. Since then, the S&P 500 is up over 50%, credit spreads are tighter, and real yields are lower. Anyone arguing that asset-purchase flows are the “only game in town” has a tough time explaining that.
Third, the 2013 taper tantrum was a stressful time for emerging-market investors, but a non-event for investors in US equities. The S&P 500 had a peak-to-trough drawdown of 5.5% in the middle of 2013. That’s it.
So, what could a genuine tapering surprise look like? The potential action is not in the timing but in the pace. Last time around, tapering took 10 months; formally announced in December 2013, it ran until October 2014. It was then another 14 months from the end of tapering to the first rate hike, so it was a two-year process before we reached the serious business of rate hikes.
We think the timelines can be compressed this time around, but note that even the most hawkish voices on the FOMC are talking about end-2022 as the likely “lift-off” date.
That means that the real yield on cash (almost certainly) and on government bonds (probably) will remain deeply negative for the foreseeable future. There is plenty of discussion about overvalued equity markets, but the forward earnings yield on the MSCI World is still in the region of 5%. That looks mighty tempting in a world with $16 trillion of negative-yielding debt.