The taper tantrum begins

Markets had so far shrugged off the prospect of central-bank monetary tightening. But not any more.

“The stockmarket seems to... be having its ‘taper tantrum’,” say Jacob Sonenshine and Jack Denton in Barron’s. Last week the US Federal Reserve signalled that it could be ready to start reducing (or “tapering”) the amount of emergency support it gives the US economy before the end of the year. It is currently buying $120bn-worth of US government bonds and mortgage-backed securities (MBS) with printed money every month. A reduction in central-bank stimulus is bad for stock and bond prices, but markets had so far shrugged off the prospect of monetary tightening.  

Yet on Tuesday the S&P 500 fell 2%, its worst day since May, as bond yields (which move inversely to prices) rose. The benchmark US 10-year Treasury bond yield has gone above 1.5% for the first time since June. Higher bond yields prompt investors to buy bonds and ditch stocks.  

Barring serious economic turmoil, the Fed is now expected to announce tapering in November, says Justin Lahart in The Wall Street Journal. It looks poised gradually to reduce the pace of monthly asset purchases until they hit zero sometime in the middle of 2022. That could open the way for interest-rate rises before the end of next year.

On this side of the Atlantic, the Bank of England is also moving closer to raising interest rates, says Paul Dales of Capital Economics. The Bank left rates unchanged at 0.1% and the quantitative easing (QE) target at £895bn during its September meeting. Yet the minutes noted that the case for some “modest tightening in monetary policy” had “strengthened” since its last meeting. The Bank appears to be more worried that inflation will stay stuck above the 2% target (which necessitates earlier interest-rate hikes) than that the economic recovery is losing steam (which would require policy to stay looser for longer).

The Bank seems to have taken a slightly “hawkish” turn, agree Sanjay Raja and Panos Giannopoulos of Deutsche Bank. Policymakers are just waiting to see what effect the end of furlough has on the job market before acting on inflation. The analysts now expect the bank to raise rates to 0.25% in February 2022, with a further rate hike in November next year to 0.5%. This week the Bank’s governor, Andrew Bailey, indicated that the Bank might even hike rates before the current QE programme finishes at the end of this year.  

The Bank of England owns more than a third of UK public debt because of quantitative easing, says Jeremy Warner in The Daily Telegraph. Easy money has saved “the Exchequer billions in debt servicing costs”. Yet growing inflationary pressure could force it to “jack up interest rates”, which will cost the Treasury billions. The health of the public finances is “a matter of growing concern”.

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