On Friday Jerome Powell, Chair of the US Federal Reserve, addresses the Jackson Hole Economic Policy Symposium, and investors are expecting to hear an update on plans for tapering the Fed’s Covid-induced quantitative easing programme. To understand why this matters, it’s worth remembering what happened the last, and only time, QE was tapered.
In May 2013, Ben Bernanke, then Chair of the Fed, raised the possibility of a reduction in the Fed’s $4tn QE programme. QE was begun in the wake of the Great Financial Crisis to support the economy after interest rates had already been cut to zero. The theory goes that by buying huge amounts of government bonds the central banks will keep borrowing costs low for the rest of the economy and provide plentiful liquidity to the banking system to encourage loan growth.
Bernanke’s comment, however, caused US treasuries to sell-off sharply as holders reacted to the news of the largest buyer exiting the market, and the US 10-year Treasury yield jumped from 1.7% to 3.0%. Stocks sold off initially as well, falling 6%. This was known as the ‘taper tantrum’. Like the reaction a child may have to their parents taking away their sweets, it was excessive distress to something which would be good for them in the long-term.
Due in part to the market volatility, the taper did not start until December, whereupon bond yields fell. This seems counterintuitive as one would expect yields to move higher as monetary policy is tightened. In fact, the tighter monetary conditions meant expectations for economic growth, and so inflation too, were lowered, making government bonds more attractive.
So, should we expect history to repeat itself at Jackson Hole?
Powell has been clear in recent weeks that no decision on tapering will be announced until sufficient progress on employment gains has been achieved, while allowing inflation to run significantly ahead of target. With US jobs data steadily improving, many market participants and policymakers are keen to see the Fed announce the beginning of the end of this controversial experiment in monetary policy.
It is unlikely that Powell will announce anything drastic. He learnt his lesson in autumn 2018 when his poor messaging about the Fed’s rate-hiking trajectory caused equity markets to fall 20% by the year-end.
This time the announcement of the taper will come as no surprise, and it is likely markets are currently priced to reflect this. In fact, perhaps the tantrum has happened already. 10-year US Treasury yields rose from 0.5% to 1.7% from last summer to March, a similar move relative to that made during the tantrum in 2013.
Perhaps the real danger comes if Powell gives too little detail around the timing of the taper. In that instance fears of the Fed’s confidence in the strength of the economy amid ongoing Delta disruption to the supply-side could grow, undermining earnings expectations and exacerbating inflation anxiety. This could be bad for both equities and for bonds. And it is August when markets can overreact on low liquidity, so we will be listening closely on Friday.