The “Taper Tantrum” revisited

In the recent Booth School of Business conference in New York, a handful of authors, from academia and the markets, conclude:

“Our procedure attributes most of the bond market selloff during the 2013 ‘taper tantrum’ to better economic news rather than to changing expectations for the end of balance sheet expansion,” the authors wrote.

Independently, David Andolfatto in a blog post reaches a similar conclusion:

Consumption growth turned positive in 2013.4, and continued to climb well into 2015. So while the tantrum may have contributed to the spike up in yields, the reason they stayed higher is because of an increasingly bullish outlook for the economy. 

I find the argument that the bond sell-off during the “taper tantrum” (TT), was due to better economic news/increasingly bullish outlook hard to swallow.

The chart illustrates.

Where:

1 Bernanke Testimony before Congress May 22 2013 ““The Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.”

2 Bernanke Press Conference June 19 2013 in which the Chairman optimistically described economic conditions and again suggested that asset purchases might be reduced later in 2013.

3 FOMC Meeting September 2013 Asset purchases maintained

4 FOMC Meeting December 18 2013 “The Committee sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month.

5 FOMC Meeting July 30 2014 All but confirms the taper will end in October. At the same time, the ECB indicates it will start asset purchases in October.

Now, monetary policy generally believed to be a major force powering the economic recovery, therefore, if the Fed is going to withdraw monetary stimulus earlier than previously expected it is logical that yields rise.

In the September Meeting (“later in the year”) when nothing happened, yields stop rising. Interestingly, when the Fed announces that the taper will slowly begin in January 2014 because the Fed sees” improvement in economic activity and labor market conditions”, yields trend down!

If the arguments that most of the bond market sell-off during the TT was due to a “bullish outlook”, I would expect to see long-term inflation expectations rise. As the chart below indicates, however, inflation expectations fall, consistent with the Fed withdrawing stimulus.

Notice that while inflation expectations remain relatively stable throughout the taper, after the July 30 2014 Meeting, when the end of the taper in October is “confirmed” AND the ECB indicates it will start asset purchases, inflation expectations take a dive!

That indicates that monetary policy was being effectively tightened. Additional evidence is provided by the broad dollar trade-weighted index chart below. The dollar doesn´t move much throughout the TT and the taper. However, the combination of no Fed asset purchases and start of ECB asset purchases, a combination that indicates relative tightening in the US, the dollar appreciates significantly.

The movements observed in long yields, inflation expectations and the dollar after mid-2014 are consistent with lowered growth expectations (not bullishness). The chart below shows that in 2015-16 real output growth shrunk significantly.

Tomorrow, Jay Powell makes his first formal appearance. He should be cautious…

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