Should you fear the taper?

This article was first published on Business Times on 22 Sep 2021.

Central banks have been talking about tightening monetary policy, starting with tapering the amount of bond purchases they make each month. Bank of Canada and Reserve Bank of Australia have already started tapering and the Federal Reserve (“Fed”) has started discussing it. However, some investors may still remember the taper tantrum of 2013 and others might have at least heard about it. Ben Bernanke, the Fed chairman at that time, suddenly revealed that the Fed was thinking about tapering during his 22 May 2013 congressional appearance. But just how badly did the financial markets react?

Table 1: Short-term drawdown after tapering announcements

Peak-to-trough	Change in 10Y US Treasury yields	Change in S&P 500 Index price
From 21 May 2013	+25bps	-3.44%
From 18 June 2013	+47bps	-4.77%
From 18 September 2013	-25 bps	-4.06%

Source: Bloomberg Finance L.P., iFAST compilations

From Table 1, the damage done to financial markets does not look that bad. However, an increase of 47 basis points for 10-year US Treasuries (“UST”) was still quite impactful. On further hindsight analysis, the S&P 500 index still managed to appreciate 29.6% one year from the 2013 bottom, despite all the volatility caused after Ben Bernanke made his congressional appearance.

Moving on, in the 2013 December meeting, the Fed announced it would start reducing its bond purchases in 2014. The 10-year UST yields hit a high of 3.03% at the end of 2013 which was not exceeded for a period of nearly five years until the Fed started quantitative tightening in October 2017. For the US stocks, they also performed quite well. In 2014 while the Fed was tapering, the S&P 500 index returned 11.4% for the year. S&P 500 investors would have gained 27.6% during the three years after the Fed ended its asset purchase programme in October 2014. When the Fed announced quantitative tightening in September 2017, the index gained 15.7% over the following year.

To surmise, tapering or quantitative tightening is not quite the “Big Bad” that investors should fear. Furthermore, Fed chairman Jerome Powell seems to be preparing market participants quite well for the eventuality of tapering. Communication is also every bit as important as actual monetary policy decisions for investors. There are various studies that show that central bank communications is a key determinant of the market’s ability to anticipate monetary policy decisions and the future path of interest rates.

To hammer home the point, we can examine the events in 2020 too. When bond prices were falling during March last year, the Fed announced they would purchase Treasury and agency mortgage-backed securities “to support smooth market functioning”, essentially suggesting infinite quantitative easing. They also established two credit facilities to buy corporate bonds to support the bond market. The bond market shortly rebounded despite the Fed only making purchases in mid-May and at its peak, held USD 46 billion in corporate bonds while dedicating an initial USD 75 billion equity investment and a maximum size of USD 750 billion for the two credit facilities.

Thus, while most market participants will be discussing about tapering asset purchases, chances are the impact on financial markets will not be that big, or lasting. The Fed would have learnt a lesson on how not to do it and Chairman Powell is also trying hard to differentiate tapering and interest rate policy. The latter suggests that the Fed still wishes to continue accommodative monetary policy while waning off some support. Thus, based on the data and this logic, investors should stay invested or continue investing even if blips in the market occur.

However, despite the low risk of a taper tantrum, investors should still look out for other events that can disturb financial markets. On Thursday (23 September 2021), the Fed will be releasing their monetary policy statement and Chairman Powell should announce their tapering plans. Additionally, it is also the coupon payment date for the EVERRE 8.250% 23Mar2022 Corp (USD) bonds and this event may garner more market attention over the other.

EVERRE 8.250% 23 Mar2022 Corp (USD) are bonds issued by China Evergrande Group. While it is widely expected that China Evergrande Group will default on their coupon payments, it is much harder to know what to expect from the consequences due to their huge liabilities and wide network of affected companies as well as investors. The immediate effects will be and are already taking place within the Chinese real estate and financial sectors.

China GDP growth will most probably be slowed, and being the second largest importer in the world, global economic growth will likely be affected too, especially emerging markets that have strong links to the country. As such, in the short term, I will closely monitor the emerging markets and Chinese equities for any attractive opportunities that may pop out. Emerging markets still have strong growth potential and these are some of the best times to accumulate investments for the long run.

When China Huarong Asset Management ran into trouble, the Chinese government took some time to bail them out. If they decide to do so again, it may take some time for them to announce measures, whether supportive or not. As such, there is no rush to go buying the dip for these distressed bonds. Perhaps a more opportune time will be when the Chinese government announces their intentions for China Evergrande Group, if at all.

Individual bond investors can keep an eye out on higher-rated Chinese real estate bonds such as COGARD 6.500% 08Apr2024 Corp (USD) and SHIMAO 6.125% 21Feb2024 Corp (USD). Their prices have dipped slightly and investors can potentially improve their total returns by adding them to their portfolios. However, their prices may fluctuate even more on Thursday, depending on how events play out.

Due to the large uncertainty surrounding China Evergrande and the heightened market volatility, investors will do well to stay nimble and watch for opportunities in spaces mentioned above.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in EVERRE 8.250% 23 Mar2022 Corp (USD) and the analyst who produced this report holds a NIL position in the abovementioned securities.