“History doesn’t repeat itself, but it rhymes.” – Mark Twain
Last week the Federal Reserve Bank Board met and didn’t announce any changes to short term interest rates. They did signal that they would begin to “taper” their bond purchases later this year, likely starting in December and finishing by mid 2022. (Source: 1. below)
In response, stocks have been volatile, with prices rising right after the meeting but falling in recent days. Bond yields have gone up, which has pressured technology (i.e. Nasdaq) stocks.
Taking a step back, the Federal Reserve has been buying $120 billion of bonds every month since March 2020 when Covid hit. (Source: 7. below) This is putting lots of cash into the economy – the Fed is taking pieces of paper (bonds) and trading it for a lot of cash. That cash has been buying everything - stocks, houses, cars, appliances, computers, gas, oil, lumber, cryptocurrencies, etc. This is exactly what the Fed wanted – to keep the economy going during the pandemic.
Has it worked? It sure seems so. Maybe too well, as inflation news and supply shortages are still on top of the news cycle. Putting less cash into the economy makes sense since demand is strong and the Fed has a mandate to keep inflation under control as well as unemployment low.
The Fed isn’t talking about raising interest rates – their projections indicate that they might raise rates above 0% next summer. It still won’t cost much to borrow money and we won’t earn much, if anything, on our bank accounts. (Source: 1. below)
A “taper” of bond purchases also happened in 2013, when Ben Bernanke was the Fed chair and the economy was still recovering from the aftermath of the 2008 financial crisis. The Fed was then buying bonds as part of its “QE” quantitative easing program to help the economy. (Source - 3. below)
The Fed’s “taper” announcement in May 2013 caused bond prices to go down and rates to go up. Stocks also fell about 6% from the date of the announcement before rebounding strongly into the end of the year. Market watchers took to calling this the “taper tantrum.” (Source - 4. below)
For stocks, the tantrum was short lived. The S&P 500 finished 2013 with a 32.1% gain and had a 13.5% gain in 2014. (Source - 6. below)
Interest rates moved up in 2013 after the Fed’s taper, with the yield on the 10 year US treasury bond going up from 2% to 3% by the end of 2013. But by early 2015 the rate on the 10 year bond had dropped back to below where it was when the Fed announced the “taper.” (Source - 2. below)
So is this the Taper Tantrum Part Two and if so what does it mean for the markets?
It wouldn’t be at all surprising if the Fed action causes a short term decline in stock prices just like in 2013. Stocks are sensitive to interest rates – if rates go up it costs companies more to borrow money. Technology stocks are especially sensitive to higher rates because their best earnings may be discounted years in the future. Stocks also look less attractive if safe treasury bonds yield more.
Combine that with the fact that stocks have rallied without a correction for almost 18 months and add in any number of other worries – the debt ceiling, China’s debt problems and technology crackdown, the strained negotiations over infrastructure in Congress and it could be a recipe for a tantrum, at least in the short term.
But the longer term view is still positive for markets – interest rates will remain low for the forseeable future, the U.S. economy is growing quickly and there are signs that the worst of the pandemic and the Delta resurgence may be past. Earnings for U.S. companies are predicted to grow strongly in 2022.
The markets survived the 2013 taper tantrum intact and while this situation isn’t a quite repeat of the past, it may very well be a rhyme.