Equity and fixed-income investors remain in the dark over when the Federal Reserve will taper its securities purchases, a potentially historic decision that could trigger a run-up in bond yields or a stock market crash, depending on how long the central bank waits to move.
At issue are $80 billion worth of Treasury securities and $40 billion worth of mortgage-backed securities the Fed will continue to buy each month until it decides to tighten its pandemic-induced, accommodative monetary policy.
The Fed has pledged not to even begin discussions of reducing these purchases until "substantial further progress" has been made on its employment and inflation goals. But Fed officials have been intentionally vague in setting the metrics for such progress, granting them flexibility in future policy plans. And with employment and inflation numbers still well below pre-pandemic levels, many analysts believe even a conversation about ratcheting down the Fed's bond purchases might not take place until 2022.
While analysts believe the Fed will taper its purchases over several months, the central bank is trying to avoid spooking markets similar to when then-Fed Chairman Ben Bernanke triggered the "taper tantrum" in May 2013 when he first indicated a coming reduction in the pace of monthly securities purchases. The benchmark 10-year U.S. Treasury yield jumped 138 basis points from 1.66% to 3.04% from the start of May 2013 to the end of that year. The S&P 500 jumped 21.4% over that time.
The surge in bond yields and a corresponding jump in the dollar relative to its G10 peers at that time pushed up the cost of borrowing and made U.S. goods more expensive compared to non-U.S. goods.
The current path toward tapering $120 billion in monthly securities purchases will be a balancing act for the Fed, said Gennadiy Goldberg, a senior U.S. rates strategist with TD Securities.
If even the discussions of tapering are launched too soon, the surprise could cause a drop in equity markets and a surge in government bond yields. If purchases continue well into 2022, yields would likely remain contained and stocks may keep their recent trend of setting regularly setting new, record highs, he said.
"The more important point to keep in mind here is that the decision to taper or not taper … will hinge on how the economy is proceeding, which may actually help drive broader markets," Goldberg said in an interview. "For example, equities may be driven more by the economic recovery than by tapering per se."
Before scaling back its $120 billion in monthly purchases, the Fed will likely need to see the same degree of progress on the employment front as it did in 2013, wrote Jay Bryson, chief economist with Wells Fargo Securities, in an April 19 note.
Total payroll employment remains 5.5% below where it was from the pre-pandemic peak, compared to the 2013 level of 1.7% below the 2008 peak when the Fed began signaling a taper in bond purchases, Bryson wrote.
In addition, the core personal consumption expenditure price index, the Fed's preferred measure of inflation, would need to "convincingly surpass" 2%, which Wells Fargo economists do not forecast occurring until the fourth quarter of 2021. The core PCE was at 0.2% in February, down from 0.3% in January, according to the Bureau of Economic Analysis. March data is expected to be reported at the end of April.
"We believe it will still be months before the Federal Open Market Committee is ready to broach the topic of tapering," Bryson wrote.
The timing of the taper hinges on the Fed's yet defined employment and price stability goals, but St. Louis Federal Reserve President James Bullard recently said that vaccination rates will play a significant role as well.
In an April 12 interview with Bloomberg TV, Bullard said the Fed could begin discussions of tapering the $120 billion monthly bond-buying once 75% to 80% of the U.S. population has been vaccinated.
"There's an interaction between health policy and monetary policy and right now its vaccination rates and that's what's driving the real economy," said Eric Stein, chief investment officer with financial services firm Eaton Vance, in an interview. "The Fed is really concerned about the economy, but you can't really get the economy really going until you get the vaccine rate up."
As of April 20, roughly 86.2 million people in the U.S., or about 26% of the total population, were fully vaccinated, according to the Centers for Disease Control and Prevention. About 40% of the population had received at least one dose of a vaccine, according to the CDC.
At the current vaccination rate, the 75% threshold is "almost certainly" less than two months away, making a June discussion of Fed tapering a possibility, said Tom Essaye, a trader and founder of financial research firm The Sevens Report, in an interview.
But in an April 15 note, Patrick Leary, chief market strategist and senior trader at Incapital, said a threshold that high is likely impossible this year since the vaccination rate may have already peaked.
"Americans that want the vaccine have made it a priority, while others are either on the fence or opposed to getting it," Leary said. "If the Fed is ever going to taper bond purchases, they are probably going to have to settle for something lower than 75%. Unfortunately, that also means that the country will likely be dealing with COVID-19 for a lot longer."
Goldberg with TD Securities said the Fed's possible timeline for vaccinations and tapering is likely "flexible" with "wiggle room" for where the rate ultimately arrives.
The market has been pricing in a start to the Fed discussing tapering in the second half of 2021 with a start to tapering in the first quarter of 2022, Goldberg said.