Bond Tapering: What to Expect When the Fed Tapers

There isn’t much historical experience with bond tapering. The first and last time it happened, it didn’t go so well, though it did give birth to one of those great Wall Street alliterations—the “taper tantrum.”

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    Bond Tapering: What to Expect When the Fed Tapers

    Bond Tapering: What to Expect When the Fed Tapers

    There isn’t much historical experience with bond tapering. The first and last time it happened, it didn’t go so well, though it did give birth to one of those great Wall Street alliterations—the “taper tantrum.”

    Before we examine what investors might expect with the Powell version of tapering, let’s examine what the first one looked like under Federal Reserve (the Fed) Chairman Ben Bernanke in 2013. When tapering plans were announced on May 22, 2013, markets reacted swiftly and harshly, selling bonds and igniting a surge in 10-year Treasury yields—from around 2% in May to 3% in December.1

    The reaction was more muted this time when the Fed signaled in July 2021 that they would begin reducing their monthly bond purchases sometime later in the year. In fact, investors collectively shrugged their shoulders. This more measured reaction may have been a result of greater transparency in Fed communications, which kept tapering plans from being a surprise to the market like it was in 2013.

    What May Lie Ahead

    If 2013 is any indication, higher yields may not be the automatic result of bond tapering.

    Bond purchase tapering under Bernanke did not begin until after the Fed’s Dec. 18, 2013, meeting. Ten-year yields peaked at 3.03% on Dec. 31, two weeks after the Fed’s announcement. A year later, yields were back down to 2%.2

    Moreover, the U.S. dollar and stocks rallied through the next year despite the tapering exercise that commenced at the end of 2013.

    Following the 2013 tapering, rates did not rise for another two years. It may be different this go-around, however, as the Fed has signaled it expects to hike rates shortly after the end of tapering in June/July 2023. It’s important to note that bond tapering does not mean the Fed’s balance sheet of about $8.5 trillion will not shrink.

    In the final analysis, a series set of one offers limited insight into how to view the future. Instead, investors are probably best served by adhering to their strategic allocations, regardless of the uncertainties that may be created by the Fed’s transition to a normalized monetary policy. That said, there may be opportunities to adjust bond durations to reflect a potentially rising rate environment, as well as review equity portfolios to determine if they are appropriately positioned for a changing landscape.

    Sources:

    1. https://fredblog.stlouisfed.org/2021/08/no-taper-tantrum-this-time/
    2. https://www.nasdaq.com/articles/dont-fear-the-taper-2021-11-01

     

    Please reference disclosures: https://blog.americanportfolios.com/disclosures/

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