Fed Tapering – Is Another Tantrum on the Way?

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Background

Since March 2020, the Fed’s quantitative easing program, meant to stabilize the economy amidst the economic challenges of Covid-19, has supported markets through the purchase of Treasuries and mortgage-backed securities. While quantitative easing was just one component of the Fed’s stimulus in 2020, its continued presence has drawn considerable attention as investors worry about a potential repeat of the 2013 Taper Tantrum. Uncertainty over the Fed’s plans to end asset purchases has been a source of interest and concern for many investors. In this report, we take a new look at the Taper Tantrum of 2013 and compare the economic context of that period with current conditions.

Putting the 2013 Taper Tantrum into Context

On May 22nd, 2013, FOMC Chair Ben Bernanke’s comments in front of a congressional committee were interpreted by market participants as opening the door to tapering. Even without a full plan in place yet, the mere possibility of an end to Fed asset purchases disrupted the market, leading to negative returns in both equity and fixed income securities. Investment grade and high yield credit spreads peaked roughly a month later before drifting back toward prior levels. Despite short-term declines, the full calendar year of 2013 still saw a strong recovery for equities and some segments of fixed income.

Within fixed income, floating rate loans held up best in the initial movement amid the market’s higher rate expectations. These expectations ended up overestimating the actual increase in the Fed Funds rate that would eventually be realized.

Rate-sensitive segments of the US Aggregate Index and intermediate to long-term US Treasuries ended 2013 in negative territory. Rising rates had a negative impact on total returns, with the 10-year US Treasury yield ending 2013 110 basis points higher than the day before Bernanke’s congressional testimony.

Economic Conditions: 2013 versus Today

Relative to 2013, current economic conditions are on a stronger footing. Inflation is currently 4.3% vs 1.7% in May 2013, GDP growth is higher, and unemployment is lower than in the pre-Taper Tantrum period. With the 10-year Treasury yield running lower than in 2013 and the Fed balance sheet four times its year-end 2008 level, conditions appear more favorable for a reduction in monetary stimulus.

The Surprise Factor is Gone

In 2013, the eventual rollback in quantitative easing was uncharted territory and the market responded to the discomforting uncertainty. Investors in 2021, with the benefit of previous experience, have a baseline with which to compare the current environment. We have arguably already entered into the most important part of the tapering process with the communication that tapering is on the way. Fed Chair Powell’s recent Jackson Hole comments opened the door to a start to tapering that could begin this year, earlier than some market participants had predicted. Markets reacted favorably, perhaps reflecting Powell’s comment that the future path of rate policy will be uncoupled from the timing of tapering. While we wait to see the exact details and timing of the Fed plan, market participants know to expect further news in coming months.

Our Position

We are cognizant of the irony that those risks with which the market is most concerned are often not the risks that induce the greatest losses. As the economic recovery continues to mature, some modest yield curve steepening can be expected. On balance, credit exposure is favored over duration.

Disclosures

The views expressed herein are those of Asset Consulting Group (ACG). They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm.

This report was prepared by ACG for you at your request. Although the information presented herein has been obtained from and is based upon sources ACG believes to be reliable, no representation or warranty, express or implied, is made as to the accuracy or completeness of that information. Accordingly, ACG does not itself endorse or guarantee, and does not itself assume liability whatsoever for, the accuracy or reliability of any third party data or the financial information contained herein.

Certain information herein constitutes forward-looking statements, which can be identified by the use of terms such as “may”, “will”, “expect”, “anticipate”, “project”, “estimate”, or any variations thereof. As a result of various uncertainties and actual events, including those discussed herein, actual results or performance of a particular investment strategy may differ materially from those reflected or contemplated in such forward-looking statements. As a result, you should not rely on such forward-looking statements in making investment decisions. ACG has no duty to update or amend such forward-looking statements.

The information presented herein is for informational purposes only and is not intended as an offer to sell or the solicitation of an offer to purchase a security.

Please be aware that there are inherent limitations to all financial models, including Monte Carlo Simulations. Monte Carlo Simulations are a tool used to analyze a range of possible outcomes and assist in making educated asset allocation decisions. Monte Carlo Simulations cannot predict the future or eliminate investment risk. The output of the Monte Carlo Simulation is based on ACG’s capital market assumptions that are derived from proprietary models based upon well-recognized financial principles and reasonable estimates about relevant future market conditions. Capital market assumptions based on other models or different estimates may yield different results. ACG expressly disclaims any responsibility for (i) the accuracy of the simulated probability distributions or the assumptions used in deriving the probability distributions, (ii) any errors or omissions in computing or disseminating the probability distributions and (iii) and any reliance on or uses to which the probability distributions are put.

The projections or other information generated by ACG regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Judgments and approximations are a necessary and integral part of constructing projected returns. Any estimate of what could have been an investment strategy’s performance is likely to differ from what the strategy would actually have yielded had it been in existence during the relevant period. The source and use of data and the arithmetic operations used for calculating projected returns may be incorrect, inappropriate, flawed or otherwise deficient.

Past performance is not indicative of future results. Given the inherent volatility of the securities markets, you should not assume that your investments will experience returns comparable to those shown in the analysis contained in this report. For example, market and economic conditions may change in the future producing materially different results than those shown included in the analysis contained in this report. Any comparison to an index is for comparative purposes only. An investment cannot be made directly into an index. Indices are unmanaged and do not reflect the deduction of advisory fees.

This report is distributed with the understanding that it is not rendering accounting, legal or tax advice. Please consult your legal or tax advisor concerning such matters. No assurance can be given that the investment objectives described herein will be achieved and investment results may vary substantially on a quarterly, annual or other periodic basis. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.

Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is an Investment Adviser.

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