Dylan S. from Nashville, TN asks: Hello Mitch, I’m curious to hear your thoughts on the timing of the Fed ‘taper,’ which seems to be discussed every week. Do you see the taper starting this year?
Mitch’s Response:
Thanks for sending your question, Dylan. I think it’s up in the air when the Federal Reserve will begin tapering their monthly purchases of Treasury and mortgage securities, and it feels a bit hazardous to guess. But I’ll lay out a few thoughts for you and readers regarding the taper and what it could mean for markets and the economy.
First, as it relates to the timing of the ‘taper,’ I would venture to say that the Federal Reserve views the current economic situation more cautiously than we do. I see surging demand in the economy and strong corporate profits, while the Fed seems to be more fixated on the unemployment rate being slightly higher than they want it to be – even though there are more available jobs in the economy than there are unemployed people.1
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I think the Fed’s September 21-22 meeting will be the ultimate tell of when we can expect tapering to begin. By that meeting, the federal unemployment expanded benefits will have ended, and we will have some data showing how the labor market/hiring is holding up as the Delta variant spreads. A strong hiring report could put some pressure on the Fed to start tapering perhaps by the end of the year, if not early next.
As for what to expect from the markets and economy, we do have one historical reference point we can look to – the Fed taper that started in December 2013 and lasted 10 months. Many can easily recall the “taper tantrum” narrative that accompanied the reduction in bond purchases, and there may be an assumption etched into folks’ memories that it was a bad time for stocks. But it wasn’t. Volatility was a factor, but the market’s trajectory remained positive:
S&P 500 from December 31, 2013 to December 31, 2014
In my view, the main reason tapering matters is because of the effect it could have on interest rates. The Fed’s Treasury and mortgage purchases have artificially put downward pressure on long-duration bond yields, and removing the purchases may allow the longer end of the yield curve to float higher. Tapering also moves the Fed one step closer to hiking the fed funds rate, all of which translate to higher interest rates in general. The expectation of higher interest rates can put pressure on stock prices, particularly names that trade at high valuation multiples, like Tech.
Time will tell, but I do agree these are important indicators to watch. I do not necessarily think tapering and pushing the fed funds rate higher will spell doom for this cycle, but it very well may open the door for higher levels of volatility and a rotation away from high valuation names. Investors should keep that in mind.
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Disclosure
2 ZIM may amend or rescind the free guide “8 of the biggest retirement mistakes investors should avoid” for any reason and at ZIM’s discretion.
3 Fred Economic Data. August 13, 2021. https://fred.stlouisfed.org/series/SP500
4 ZIM may amend or rescind the free guide “8 of the biggest retirement mistakes investors should avoid” for any reason and at ZIM’s discretion.
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