Taper Tantrum Two?

To drive home his commitment to easy monetary policy and low interest rates in mid-2020, Federal Reserve Chairman Jerome Powell declared the Fed was not even "thinking about thinking about raising rates."

The Fed meets again later this week and, very likely, is still not thinking about thinking about raising rates. But that's only part of the Fed's tool kit. Bond purchases are another, and have been running at a pace of $120 billion per month ($80 billion in Treasuries and $40 billion in mortgages). With inflation up, and the economy growing, the Fed is most certainly thinking about how to "taper" this bond buying.



As a result, some investors are worried about the impact on financial markets. Back in 2013, when Fed Chairman Ben Bernanke hinted that the Fed would slow the pace of quantitative easing, the 10-year Treasury yield jumped from roughly 1.7% to 3.0%, while the stock market hit an air-pocket. This rough patch for markets was famously dubbed the "Taper Tantrum."

That financial turbulence was enough to put Bernanke and the Fed back on its heels, and they ended up postponing actual tapering until the beginning of 2014.

So, what happens this time? It's true that monetary stimulus has been a key part of the current recovery from pandemic shutdowns. However, with so much liquidity in the financial system, we are skeptical that a policy shift toward tapering would create the same kind of market response for a few reasons.

First, the bond market has experience with tapering. When tapering finally ended in October 2014, bond yields were back down to about 2.3%. In other words, the tumult in markets was temporary. Eventually, the Fed didn't just taper, it shrunk its balance sheet, which bottomed in August 2019 when the 10-year yield was back down to about 1.6%. So, after all the fear about tapering, yields eventually fell back to where they were before Bernanke even talked about tapering in the first place.