|Federal Reserve Chairman Jerome Powell has resisted pressure to take a more hawkish tone, insisting that inflationary pressures are temporary and committing to the central banks $120 billion a month asset purchases.
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Even as the global economy recovers, central banks are in no rush to halt their quantitative easing programs. If investors lose faith in monetary policy, though, a repeat of the 2013 bond yield debacle will be more likely, analysts say.
The U.S. Federal Reserve, European Central Bank, Bank of Japan, Bank of England and others have already bought trillions of dollars in government and corporate bonds — bloating their combined balance sheets to about $25 trillion — to keep borrowing costs down and limit the number of defaults and bankruptcies caused by pandemic-related lockdowns.
Those central banks are now looking for the right time to turn off the taps of monetary support as vaccines roll out and countries unlock. The fear of repeating the taper tantrum of 2013 — when then-Fed Chairman Ben Bernanke spooked investors by indicating a reduction in monthly purchases of Treasurys, triggering a spike in borrowing costs — is part of the reason why only the Bank of Canada has started scaling back purchases.
"The 'pact' between investors and central banks is that they will maintain stimulus packages and bond markets will behave themselves," Colin Finlayson, co-manager of Aegon Asset Management, said in an email. "One wrong word from a central banker and it's 2013 all over again."
But investors are increasingly concerned that the actions of the central banks are out of step with the reality of inflationary pressures stemming from growing demand, supply constraints and extensive government spending.
"The worst-case scenario would be one in which the Fed continues sending an accommodative message despite a changing reality on the ground, only to end up changing its stance," Kambiz Kazemi, chief investment officer for Validus Risk Management, said in an email. "This, combined with poor communication, will create a sense of abruptness resulting in risk-off for assets and a move higher for rates."
Federal Reserve Chairman Jerome Powell committed to maintaining the bank's $120 billion weekly asset purchases at the Federal Open Market Committee's two-day meeting in April, insisting that the combined inflationary pressures of pent-up demand and supply bottlenecks are temporary.
But investors are nervous. The yield on 10-year Treasurys climbed 0.05 percentage point to 1.69% on May 12 after the U.S. consumer price index jumped to 4.2% in April, the highest level since 2008 (investors demand higher yields when they expect higher inflation to eat into their margins). And earlier this month, U.S. Treasury Secretary Janet Yellen was forced to backtrack from comments she made suggesting that a rate hike would be required after the S&P 500 fell 0.7% on the day.
"The longer central banks wait to taper, the bigger the chance for a taper tantrum," Althea Spinozzi, fixed income strategist at Saxo Bank, said in an email. "Yields worldwide can only move higher. Whichever [central bank] starts first, it will drag the others."
The Bank of Canada made the first move, announcing April 21 that it would scale back its weekly purchases of Government of Canada bonds by 25% to C$3 billion per week.
The bank said it expected inflation to overshoot the 2% inflation target — with inflation at 2.4% by the final quarter of 2023 — driven by booming house prices along with good progress in the economic recovery.
The U.S. dollar has fallen to C$1.21 from C$1.25 since the decision, the lowest level since September 2017. ING Bank forecasts the U.S. dollar will fall to C$1.16 by the end of 2021 as a result of the Bank of Canada being the "hawkish standout in the G10 space."
The Bank of England is also slowing its pace of weekly purchases of gilts — U.K. government bonds — by £1 billion to £3.44 billion.
The bank denied it was "tapering," instead claiming the move was necessary to meet the target of £875 billion by the end of 2021. Yet the bank adopted a bullish tone on the economy, noting a sharper-than-expected recovery in domestic investment and consumer spending, buoyed by a successful vaccine program. The bank raised its GDP forecast for 2021 to 7.25% from 5%.
While the flood of government support and rising consumer prices have given many market observers inflation jitters, central bankers are less concerned. So far, at least, inflation readings continue to lag most countries' 2% target.
The European Central Bank reaffirmed its commitment to completing its €1.85 trillion asset purchase program the day after the Bank of Canada's announcement. The euro area's economic recovery has been hamstrung by a third wave of COVID-19 cases, and the bank is more interested in maintaining low borrowing costs than easing up on asset purchases.
The crisis of the last decade, when the cost of government debt spiraled unsustainably for southern European countries such as Greece, Italy and Spain, haunts the memory of policymakers who are keenly aware that countries have since taken on even more debt. The spread between Italian and German 10-year government bonds — a crucial metric for highlighting investor concern that the euro area will break up — has been creeping up as yields rise across the continent.
"The ECB would only be comfortable with the higher level of yields if the outlook for inflation over the medium term had significantly improved," Nick Kounis, head of financial markets research at ABN Amro, wrote in a May 11 research note. "However, this is unlikely to be the case."
In Japan, policymakers have the opposite concern: stagnation rather than inflation. The rate was negative 0.1% in March and has not been positive since September 2020. Meanwhile, the Reserve Bank of Australia is waiting for the slack in the labor market caused by the pandemic to fade before tightening policy.
Most central banks have clear timelines for when their purchasing programs will end, but that is not the case in the U.S. As a result, communication — and retaining market confidence — will be crucial to avoiding disruption when the Fed eventually decides to taper, experts say.
"The fact that the market has started to price in higher rates and, in the last few days, give signals that it does not believe the Fed, is a healthy development as long as the correction remains orderly," Validus' Kazemi said. "However, in the next days and week we should watch if price action stabilizes."