The Week Ahead – Lipstick on a Taper

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

Back in 2013, markets were roiled by what market pundits coined as the “Taper Tantrum.” Federal Reserve policymakers announced their plan to wind down the controversial quantitative easing (QE) program at the end of that year. Then Chairman Ben Bernanke first revealed the strategy to unwind emergency economic stimulus during an appearance before Congress’ Joint Economic Committee. “If we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings ... take a step down in our pace of purchases,” Bernanke said. Bond yields rocketed higher and stock prices dropped by nearly 5% in the coming weeks. Indeed, financial conditions over the ensuing months tightened, surprising the Fed. Eight years later, the lessons of 2013 echo loudly, as the Fed once again debate the fate of the central bank’s massive balance sheet and struggle with the potential market volatility.

This Wednesday, the Fed statement may signal that tapering will begin in November. The argument for the Fed to announce its plan to reduce bond purchases is fairly straightforward. Evidence is mounting that the Delta variant has peaked, which will allow the economy to get back on track and continue to accelerate into the back half of the year. Keep in mind, there was an extra $4.2 trillion in savings (19% of GDP) sitting on the balance sheets of households and businesses at the end of the second quarter. This unprecedented financial firepower will eventually be deployed. The issue is whether the market reaction function creates a negative feedback loop causing a greater tightening of financial conditions than desired by policymakers. While bond issuance in the third quarter has been the lowest in more than two years, the Fed has continued purchasing a $120 billion of U.S. debt every month, keeping bond yields near historic lows.

In addition to tapering, there is a looming vote to raise the federal debt ceiling in the face of strident GOP opposition. The combination of the potential taper announcement and the threat of the government running out of cash could create a white-knuckle ride. Despite continued political dysfunction, Congress has always found a way to avoid catastrophe. Jerome Powell, the current Federal Reserve Chairman, was a member of the Fed during the 2013 taper, and has proven to be adept at steering the rudder through very difficult waters.

While there may be heightened volatility in the near-term, the fundamentals of the economy are strong, and have reached a self-sustaining phase. Last week, we saw blowout reports for both retail sales and job openings. The increase in jobs lifts consumer incomes, which lifts consumer spending, which further lifts employment. We expect this positive feedback loop to continue, making the Fed’s eventual decision to taper bond purchases entirely appropriate.

Data deck for September 20–September 24: