Self-help guru Tony Robbins once said, “It’s not what we do once in a while that shapes our lives, it’s what we do consistently.”
Does anyone remember the summer of 2013? U.S. interest rates shot up 100+ basis points (bps) and spreads of fixed-income bonds widened significantly… why? Most would contend that the “taper tantrum” was to blame. “Tapering” is the term used to describe the Federal Reserve’s efforts to reduce the amount of money it was feeding into the economy. A “tantrum” ensued because the Fed, at the time, was in the midst of adding assets and had previously indicated the purchases would persist. Thus, the announcement by then Chairman Ben Bernanke that the Fed would reduce purchases was “inconsistent” and caused market panic. Investors, particularly fixed income investors, do not like surprises. Expected news, no matter how bad, is almost always better than unexpected news.
Fast forward to fall 2016 when the Fed announced an end to increasing its balance sheet size and stated levels would be maintained for a while. One year later they announced modest reductions would occur passively, meaning a portion of amortizing or maturing positions would not be replaced. However, this time, the reductions were communicated, calculated and, most importantly, CONSISTENT. In 2017 and again in 2018 there has been “tapering” but this time there was no market “tantrum” that followed.
This month the Fed will officially end all re-investments of Treasuries and mortgage-backed securities (MBS), delivering precisely what was communicated. The market has been expecting this event for more than a year. Yes, yields are higher mostly due to economic growth, but rate volatility has been subdued. The Fed also raised short-term interest rates four times in the past nine months as predicted. MBS spreads widened modestly at the beginning of the year but have been quite stable since.
So there you go. Before they were buying or replacing tens of billions of dollars each month and now nothing. Yet the market is fine, or as one colleague put it, “rather boring.”
If only the rest of the market was so boring. Unfortunately, there is no shortage of uncertainty. From a central bank perspective, the primary concern on our mind is: Will policy makers run out of time and lack the firepower needed to combat any growth headwinds? In this context, the Fed is in much better shape than its global counterparts (the end of “tapering” representing another step in the right direction). However, real yields in Europe and Japan linger within or near negative territory. The lack of rate hikes makes dealing with the next downturn that much harder. As fixed income investors, this is a risk we will be watching closely.
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