Tapering is Not a Fashion Statement
There’s been a lot of talk about tapering lately and we’re not talking about the slim fit that is the style for men these days, we’re talking about the Fed’s balance sheet. Here’s what you need to know.
- For most of the period from late 2008 to today, the Fed has been on a buying spree of various assets, particularly Treasuries and mortgage-backed securities. In the process, it has increased the size of the Fed balance sheet from approximately $1 trillion to over $8 trillion today.
- More demand typically results in higher prices, other things being equal, and that implies that this Fed buying spree has been a significant driver to the incredible rise in asset values over the last 12+ years.
- Tapering simply means that Fed is going to reduce the size of this buying spree, with the intention of ending it completely at some undefined point in time.
- In the past, efforts to taper (see the chart below) have resulted in ‘taper tantrums’, meaning that markets came a bit unglued when the Fed tapered. The implication is that other things being equal, less demand should lead to lower asset prices and so the market reacts poorly to tapering.
- The Fed appears ready to start tapering, the question is how far will this go before the market pushes back with another ‘taper tantrum’.
- We can only guess, but we suspect it won’t take long. At that point the more important question will finally be asked.
- Will the Fed cave and resume purchases in response to the tantrum?
We, like everyone else on Wall St., can only guess at the answer, but we will make the following observations/arguments:
- The Fed has a strong desire to ‘normalize’ its behavior in markets, despite the difficulties in doing so. The implication is that at some point, like any good parent, it must ignore the tantrum of the unruly child and act anyway.
- Although unfilled jobs actually outnumber the unemployed, the unemployment rate remains quite high. The Fed does not want to put a crimp on the re-employment of these people, so tapering now would not align with their desired result.
- Inflation is running hot, which argues for tapering sooner rather than later, but the Fed has argued that most inflation we see now is transitory.
Fed Chair Powell spoke on Friday at the annual Jackson Hole Symposium and essentially said the following:
- Inflation targets have essentially been met; Fed will remain on guard for signs of a more permanent inflation.
- Employment continues to improve, but the spread of Delta presents risks for that trend.
- The timing and pace of tapering (when it comes) has no influence on the timing and pace of potential interest rate increases.
Our conclusion is that the table is now set to begin tapering, but the statement on Friday is clearly attempting to head-off a repeat of past taper tantrums. The success of this messaging will become clearer when the taper actually begins. For now, the stock market appears pleased by the tone of Chair Powell’s statement – neither too dovish nor too hawkish.
There is some initial evidence that the Delta surge could be easing in the areas that were earliest hit. If that trend continues and school openings do not create another resurgence, we can expect a tapering announcement sooner rather than later.
Is the Delta Surge Ending?
Some pundits are projecting an end to the Delta surge based the number of cases rolling over in the states hit earliest. Of course, schools are, or are about to, re-open and this variant appears to affect kids more readily than the original, so it’s hard to draw conclusions just yet. Below is the latest from the CDC based on 20+ models from the scientific community which show that it’s pretty much a toss-up.
It’s hard to know what to wish for. From a health perspective, we clearly want this recent surge to subside. From an economic viewpoint, if the surge declines here, but worsens in largely unvaccinated Asia, it could magnify and prolong supply chain issues, which would logically magnify and prolong inflation issues. That does not create a desirable result for the economy or markets.
As always, it is an unpredictable world. Predicting the future is not easy and predicting it consistently is impossible, which is why we stick to our plan, and leave the predictions to others.
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