Central bank tapering and the unwinding of at least part of the trillions of dollars that has been pumped into the global economy over the past year is making its way into investment debates at money management firms.
Executives think such tapering will have less effect on markets than the taper tantrum caused by then-chairman of the Federal Reserve Ben Bernanke's comments in 2013, largely because the Fed has learned from that episode and therefore is expected to carefully flag its planned unwinding.
But not expecting a taper tantrum does not mean managers think the market reaction will be benign, and, as such, managers are tweaking portfolios in terms of duration in particular.
"The sheer scale of QE (quantitative easing) and the amount of support that has provided to financial markets is such that when we do reach a kind of inflection point, which will come with tapering, then … that's going to be potentially quite a big deal for markets," said David Riley, chief investment strategist at the $75.2 billion BlueBay Asset Management LLP in London. "And so it's definitely something which is starting to come onto the radar and people are getting focused on that."
Fed committee members are starting to signpost tapering, introducing the topic into the broader market narrative and discussion "to I think pave the way for us scaling back … the volume of asset purchases. I reckon with the major central banks — the Fed and ECB (European Central Bank), but also the Bank of Japan and to a lesser extent the Bank of England and others, they've probably bought about $6 trillion worth of assets since March last year," Mr. Riley said — a figure that is "off the charts" relative even to the 2008-2009 global financial crisis.
That stimulus has provided a huge amount of support for markets and facilitated to a great extent the market recovery from the depths of the COVID-19 pandemic.
"The tapering is going to mark the first point of inflection in that — from that point on there's going to be at the margin less support coming from central banks and policymakers more generally. I think it is going to be a test for the market," Mr. Riley added.
Joern Wasmund, regional investment head for Europe, the Middle East and Africa at the €820 billion ($941 billion) DWS Group in New York, said the Fed has become better at communicating its decisions and so "we will not experience something similar like the Bernanke tapering. However, as soon as the Fed start hiking, the market knows the direction of the next move and the next move … this will have a meaningful impact on rates, particularly in five years."
As long as inflation expectations are kept under control, the Fed and other central banks moving to taper should be able to keep tapering and its effects on markets under control, Mr. Wasmund said.
U.S. long-bond yields will gradually move higher in the second half of this year, but a "bond tantrum" is not expected, HSBC Asset Management's Joe Little, London-based global chief strategist, said in an email.
The U.S. yield curve is already steep following a significant repricing of inflation risks over the past six months, meaning markets have already factored in "a significant amount of news around recovery and the journey toward policy lift-off." That makes the scope for markets to overreact to tapering news more limited, Mr. Little said.
However, there is a risk to this scenario: "A faster cyclical upturn and economic overheating, which could force a change in the Fed's strategy," Mr. Little warned. "Such (a) scenario of faster rate rises would then challenge market valuations in credit, equities and emerging markets."
Another risk is that tapering is interpreted — "perhaps wrongly, but it is perception that matters — as a signal of the future policy rate path," said Jean Boivin, managing director, head of the BlackRock Investment Institute in New York, in an email. "The risk is not taper itself, but that of a significant reassessment of the policy path that would lead to an abrupt adjustment in long-term rates." That could be "very disruptive and more fundamentally call into question views on risk assets and on EM in particular," Mr. Boivin said. As such, institute executives think the Fed will try to "divorce" the policy rate from tapering.
The institute sees tapering as a risk for near-term market volatility, "but one that we would look through," he added.
Credit may be in danger if the Fed is forced to move more quickly, said Colin Reedie, London-based head of active strategies at Legal & General Investment Management Ltd. In that case, "we think the cycle models move in a less favorable direction," with mid- to late-cycle being a good time for equities "but credit worries," Mr. Reedie said. LGIM has £1.3 trillion ($1.8 trillion) in assets under management.
Markets have already had a small taste of what's to come: Alongside passing comments from U.S. officials on the need to potentially begin conversations about tapering, the Fed has already signaled the imminent unwinding of some stimulus.
Executives at Insight Investment discussed the ending of the Fed's emergency corporate bond buying following an announcement this month that it would gradually sell the almost $14 billion in COVID-19-related purchases under its Secondary Market Corporate Credit Facility.
Although the amount is "tiny it is still a step because (the Fed is) getting rid of some of these extraordinary measures — that's just one that isn't necessary anymore," said April LaRusse, London-based head of fixed income at the £707.7 billion firm.
The sale of some of the Fed's corporate bond holdings also sparked conversation at the 134.6 billion Swiss francs ($149.5 billion) Vontobel Asset Management AG. While the amount is "not a lot, that was still instrumental," said Simon Lue-Fong, London and Zurich-based head of fixed income. The establishment of the extraordinary monetary and fiscal support in March 2020 "was a positive boost to the market. (The Fed) had an option that they could have let things mature and not said anything," showing officials feel confident in the selling of bonds not causing huge moves.
"The market took that pretty well. So we're in motion already and that's all part of allowing us to price" tapering in, Mr. Lue-Fong said.
Vontobel executives aren't necessarily worried about rates going up, but rather "what we're worried about is the volatility of assets."
However, the roughly 70-basis-point move in Treasuries in the first quarter, to about 1.7%, didn't have much impact on risk assets or volatility — giving some comfort. "This is what the Fed would want and we all want — Treasury yields can move higher with tapering having this impact, but you don't get this mass sell-off in risk assets — which by the way is always a risk because the market is so over-owned and from a valuations perspective, we're pretty full." Mr. Lue-Fong thinks Treasuries could "easily" rise to around 2%.
Managers expect further details on tapering plans to come out of the central bank's Jackson Hole Economic Symposium conference in August, with Fed tapering set to begin next year.
Nonetheless, money managers are starting to prepare portfolios for a U.S. tapering announcement.
While Lombard Odier Investment Managers executives feel the taper story from the Fed "is extremely well flagged … (and) we don't think the market will struggle digesting the information," there are still risks out there and tapering is an "important topic for everyone," said Philipp Burckhardt, fixed-income strategist and portfolio manager in Basel, Switzerland.
The 63 billion Swiss francs firm is seeing demand for flexible fixed-income strategies or dynamic bond funds, which can "shift quite aggressively when needed … products that are nimble are something investors can identify with at this potential juncture."
BlueBay is preparing in relation to its short-duration views — "where we see a decline in Treasury yields, at the margin (we are) adding to our short-U.S. rates position across a number of our strategies. If we do get an announcement around tapering at Jackson Hole, a bit earlier than the market expects, and if the ultimate pace of tapering proves to be somewhat quicker … that will have an impact in terms of when the market is pricing the liftoff from zero in Fed fund rates," which would push Treasury yields higher, Mr. Riley said.
The firm is adding high-yield bonds, collateralized loan obligations, short-duration emerging markets credit and sectors that benefit from higher rates and a steeper yield curve, such as banks, which "could do relatively OK even if we get some volatility associated with tapering," Mr. Riley said.
Others think patience is a virtue right now. HSBC AM executives think investors "should position themselves close to their home portfolio, not taking too much directional risk, and adopting a patient approach," Mr. Little said.
And patience is the approach being taken by Insight Investment. Short-duration positions are "really expensive and the yield curve is really steep," but executives don't want to be long either. "We're essentially waiting for the market to move," Ms. LaRusse said.
Vontobel hasn't taken many duration bets right now either, Mr. Lue-Fong said. "We're sort of in wait-and-see mode," and investors will probably be back to more tactical operations by the end of the summer, he added.
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