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US Federal Reserve Board chairman Jerome Powell testifies on the Fed’s response to the pandemic on June 22. Unlike in 2013, when a surprised market went into a “taper tantrum”, this time, Powell has been carefully preparing the ground. Photo: AFP
Opinion
Macroscope
by Tai Hui
Macroscope
by Tai Hui

Forget the 2013 ‘tantrum’ playbook as the US Fed prepares to taper its bond buying

  • In 2013, Treasury yields fell as tapering began, leaving bond and corporate debt markets higher. This time, US bond yields are likely to rise and could dampen returns in a stock market already jumpy from overheated valuations
Tai Hui
Tai Hui
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As the US Federal Reserve gets ready to roll back its quantitative easing programme and start tapering its asset purchases by the end of the year, investors can’t help but recall the 2013 market “tantrum” that greeted the Fed’s previous attempt to taper its bond buying, as they decide what to do now.

But there are important differences between then and now that should caution investors against simply copying and pasting their 2013 playbook.

After the Fed announced, in December 2013, that it would begin to reduce its bond buying, both equities and fixed-income securities ended up having a good year in 2014. The S&P 500 was up 13.7 per cent, and the MSCI Asia-Pacific ex-Japan index was up 3.1 per cent. US government bonds and investment-grade corporate debt also delivered returns of 6.1 per cent and 7.6 per cent to investors that year. So far so good.

Yet, if you dig deeper into the numbers, you can see there were considerable differences between markets that showed the Fed’s policy change was not the only game in town.

While US equities brought handsome returns, European equities were still struggling in the aftermath of the region’s sovereign debt crisis, with the MSCI Europe index down 5.7 per cent in 2014.
Masked demonstrators in June 2012 depicting (from left) then French president Francois Hollande, German Chancellor Angela Merkel, Spanish prime minister Mariano Rajoy and Italian prime minister Mario Monti simulate playing a soccer match to protest against the euro-zone debt crisis, in front of the Chigi Palace in Rome. Photo: Reuters

In Asia, the 3.1 per cent return generated by the MSCI Asia-Pacific ex-Japan index in 2014 also masked a wide divergence among Asian markets. India was up 26 per cent that year while South Korea was down 10.7 per cent.

Also, the index’s overall performance did not reflect the 46.5 per cent boom that took place in the onshore A-share market in China, led by Chinese retail investors.

These examples show that not every market dances to the Fed’s tune, and that local economic and financial conditions were important in determining investment results. In the same way, for 2021, how governments and businesses cope with the Covid-19 pandemic is critical in delivering economic growth and thus, investment returns.

In addition to the variations in market performances, the economic and market conditions this year are also quite different from 2013.

Let’s start with US government bond yields. The benchmark 10-year Treasury yield was at nearly 3 per cent in December 2013 when the Fed’s official tapering announcement was made, compared with around 1.35 per cent today. The Fed chairman at the time, Ben Bernanke, surprised the market by discussing a reduction in bond buying in May 2013, which led to a spike in government bond yields that became known as the “taper tantrum”.

In contrast, current Fed chair Jerome Powell has been very careful in preparing the market for policy changes.

Why Asian markets will not be burned by a US bond ‘taper tantrum’

This difference in Treasury yields at the start of the tapering of quantitative easing could lead to very different results for bond investors. The 10-year Treasury yield fell in 2014 by almost one percentage point. Since bond prices rise as bond yields fall, this contributed to the strong 2014 return for US government bonds and investment-grade corporate debt mentioned above.

The challenge in 2021 is that Treasury yields are still very low, especially given the pace of recovery and the inflationary pressure facing the US economy. As the Fed gradually slows its bond buying, Treasury yields are likely to rise. This could lead to a decline in prices across the fixed-income asset class and suppress returns for investors.

Another major difference is in equity valuations. At the end of 2013, the S&P 500’s estimated price-to-earnings ratio was 14. Today, it is 21. Expensive stock valuations do not lead to a market correction on their own. However, it makes the equity market more sensitive to bad news, such as disappointing earnings results or economic data.

The result of a football match played six months ago may give us an idea of how things could turn out next time, but it is not an accurate way to predict the score. This also applies to the Fed’s plan to step back from its massive bond-buying programme.

While the Fed’s policy change is an important factor to consider in portfolio construction, other economic and financial conditions should not be neglected.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management

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