What to Expect When You’re Expecting a Taper

26 8月 2021
5 Minute Read

Many investors, perhaps scarred by 2013’s “taper tantrum,” are focused on the likelihood that the Federal Reserve will start reducing its bond purchases in the next few months. We don’t think the taper will be disruptive—the Fed has learned from the market’s adverse reaction to that surprise policy turn. But we do see a taper coming soon.

Here’s our thinking on four big questions on investors’ minds:

When Will the Fed Start Tapering?

We can’t truly be confident that the market will take the taper in stride until the taper actually starts. Last December, the Fed indicated that tapering would begin after “substantial further progress” toward the central bank’s employment and price-stability objectives.

With inflation above target, this stage of the cycle is all about the labor market (Display). The US economy has added close to 4 million jobs so far in 2021, including nearly a million in July alone. Especially strong August numbers might trigger a taper announcement at the Fed’s September meeting, but we think the risk of labor-market complications from the COVID-19 Delta variant are more likely to result in a wait-and-see stance.

Job Growth Has Remained Robust in 2021
US Non-Farm Payroll Jobs (Millions)
Monthly non-farm payroll employment since 1999

Past performance does not guarantee future results.
Through July 31, 2021
Source: Bureau of Labor Statistics and AllianceBernstein (AB)

Early indications are that the Delta variant won’t throw a wrench into the labor market, and we expect strong performance to continue as summer turns to fall. Based on this assessment, we still expect a taper announcement to happen at one of the Fed’s fourth-quarter meetings this year.

How Will the Fed Engineer the Taper?

The Fed’s priority is to avoid disruption, making the successful 2014 taper a logical starting point for mapping the approach this time. However, the composition of today’s asset purchases is different. The Fed is buying $80 billion in US Treasury securities and $40 billion in mortgage-backed securities (MBS) monthly. In 2014, purchases were more balanced: $45 billion in treasuries and $40 billion in MBS.

We think the Fed has two options in engineering the taper. The first is to equally reduce treasury and MBS purchases as it did in 2014, which would wind down MBS purchases several months before treasury purchases halt. The second option is a proportional taper: reducing treasury purchases twice as fast as MBS purchases, leading both programs to wrap up at the same time, also as in 2014.

Some Fed leaders advocate equal reductions, stopping MBS purchases faster as a means to reduce support for an already surging housing market. Others—including some of the more influential leaders—don’t feel the same sense of urgency. They advocate the second option, with proportional tapering. Market expectations have coalesced around the proportional approach.

How Fast Will the Fed Taper This Time Around?

In 2014, the Fed started to taper in January and finished 10 months later. So, it’s not surprising that most onlookers expect the same pace in this iteration, which would require reducing treasury purchases by $10 billion per month and MBS by $5 billion. This seems like a reasonable baseline expectation, though the risks—and some Federal Open Market Committee members—lean toward a speedier taper, given the much faster economic expansion and more aggressive fiscal policy.

As noted earlier, the Fed could sell equal amounts of treasuries and MBS monthly (say, $10 billion), then maintain the total tapering pace once MBS purchases are wound down by reducing treasury purchases by $20 billion per month. Alternatively, the central bank could accelerate the pace—for example, reducing treasury purchases by $15 billion and MBS purchases by $7.5 billion monthly.

Or the Fed could elect to adjust the pace along the way, starting slow and then accelerating if the economic situation warrants. While we expect the Fed to indicate that the pace of tapering is flexible in theory, in practice we expect that the bar to alter the rate will be relatively high, as it was last time. That said, investors should remember that nothing is set in stone and that circumstances could force the Fed to change its plans.

What Happens—and Doesn’t Happen—After QE?

In our view, the most powerful part of quantitative easing (QE) from a monetary policy perspective is the signaling effect: investors assume (correctly, we believe) that the Fed won’t raise rates while engaged in QE. The market’s extremely high confidence that the policy rate will stay at zero and interest rates will remain generally low during QE has bolstered both markets and the US economy.

The Fed leans into that confidence, having indicated repeatedly that rate hikes are unlikely on the heels of ending QE. More than a year elapsed between the end of QE in October 2014 and the first rate hike in December 2015; the pace will probably be faster this time, given rapid growth and accelerating inflation. Markets price the first rate hike as happening in the first quarter of 2023—roughly six months after tapering seems likely to wrap up. That’s a very long way away, of course, and a lot can change.

While the elapsed time between Fed tapering and interest-rate hikes may be different from 2014, there’s one key aspect of QE that we don’t see changing: the Fed is highly unlikely to unload the bonds it has already purchased (Display), leaving a massive portfolio of securities.

Huge Balance Sheet Makes Fed Major Player in Financial Markets
US Federal Reserve Balance Sheet (USD Trillions)
The size of the Federal Reserve’s balance sheet in trillions since 2003

Past performance does not guarantee future results.
Through July 31, 2021
Source: Federal Reserve Economic Database and AllianceBernstein (AB)

In the wake of the global financial crisis, the Fed’s balance sheet doubled from $1 trillion to $2 trillion, and continued to grow rapidly in the ensuing years, topping four trillion in the years preceding COVID-19. The response to the pandemic doubled the Fed’s balance sheet yet again, to just over $8 trillion today. That scale makes the Fed a major debtholder that can have a sizable market impact.

So, it seems abundantly clear that, even if QE may end in relatively short order, the Fed is going to be a major player in US financial markets for many years to come.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

References to specific securities are presented to illustrate the application of our investment philosophy only and are not to be considered recommendations by AB. The specific securities identified and described do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable.

Investment involves risk. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This article is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor's personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer of solicitation for the purchase or sale of, any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This presentation is issued by AllianceBernstein Hong Kong Limited (聯博香港有限公司) and has not been reviewed by the Securities and Futures Commission


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