The Fed and Bond Purchase Tapering
At the outset of the Coronavirus fallout, the Federal Reserve acted swiftly with quantitative easing in an effort to apply pressure to the wound that shutting down the economy in the interest of public health caused. The magnitude of the Fed’s intervention was simultaneously necessary and staggering. It is helpful to put its $7.8 trillion dollar balance sheet into context by weighing this against the United State’s GDP, which in 2020 was $20.93 trillion .[1][2] Plainly, the Federal Reserve’s balance sheet is as large as 37.2% of annual GDP, and their asset purchases have not stopped, coming in at $80 billion worth of Treasury Bonds and another $40 billion worth of mortgage bonds every month. By all accounts, the Fed did a fantastic job in intervening quickly last year with its full weight - the difficult path forward is determining how to unwind the asset purchases with limiting shockwaves in financial markets.
Going forward, there is a complex balance that must be reached as the Taper Tantrum in 2013 is fresh in both the Fed and investors’ minds. In 2013 Ben Bernanke, chairman of the Federal Reserve at the time suggested that at some point in the future, the Fed would “reduce the volume of its bond purchases”. [3] The markets reacted as analysts and financial pundits played into the narrative that the economy would capsize due to the tightening of the Fed’s balance sheet. The selloff in bond markets was violent, and while equity markets dipped, the market’s jitters were short lived as the Fed assured investors that the economy was on good footing. Recently the Fed has stressed that they are watching the unemployment rate closely, considering employment levels a key factor in their policy decisions. As Americans return to work with the continued vaccine rollout, it can be argued that the Fed’s work is all but done, and that continuing to emerge from the dismal state of last year is predicated on reopening and refilling jobs. We are beginning to catch some wind in our sails, soon enough we may not need the Fed’s outboard motor also propelling us along, and as time progresses there will be increased scrutiny of $120 billion per month in quantitative easing.
The issue is determining when the right time to reduce these purchases is, especially considering the dovish tone that the Fed has stressed since the beginning of the pandemic and throughout 2021 to this point. In professing such an accommodative stance, any change from this attitude seems to present the likelihood for panic in markets and swift selloffs if we are simply using history as a benchmark. The likelihood of volatility in markets as a result of the eventual tapering is not meant to serve as an evergreen prediction, but determining the appropriate time to start reducing Fed purchasing will also require a delicate path forward as the need for action will not appear as evident when compared to March of last year as the world effectively shut down.
The timeline for carrying out this bond purchase tapering will become more visible as time passes, which should raise the question for investors determining whether the market will price in these realities or hang Chairman Powell’s on every word as a plan forward is devised. Considering recent events, the latter seems to be a higher probability; when Biden recently announced the plan to potentially double the current capital gains rate for individuals earning over $1 million per year, the markets sold off in reaction to his comments. Stocks sold off following the announcement despite the fact that Biden campaigned on the notion of increasing capital gains tax rates for months. As the adage goes “the market already knows”. This does not necessarily mean the market will not still react.
Refocusing on the issue of bond purchase tapering that is to come, the Fed is aware of the consequences of their remarks and that financial markets may react to their sentiment. The bright side of this is Powell’s familiarity with the events of 2013; it is reasonable to assume that he has thought about the inputs and consequences of the events that took place in 2013, and how the Fed at the time was able to recalibrate their remarks and the market propelled higher. To revert to another adage, “the market does not repeat itself, but it often rhymes”. We may see similar events compared to the Taper Tantrum of 2013 take place, but this should only emphasize the importance of durable, all-weather portfolio allocation that is proactive in the face of both our immediate and long term obstacles in the economy and markets.
Disclosures & Sources:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Content in this material is for general information only and is not indebted to provide specific advice or recommendation for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The Financial Consultants at Vintage Wealth Advisors are registered representatives with, and securities offered through, LPL Financial, Member FINRA/SIPC. Investment advice and financial planning offered through Financial Advocates Investment Management, DBA Vintage Wealth Advisors, a registered investment advisor. Financial Advocates Investment Management, Vintage Wealth Advisors, and LPL Financial are separate entities.