By Philip Lawlor, head of Global Investment Research
The jarring retreat in global bond markets this year has provoked comparisons to the mid-2013 Taper Tantrum, when the Fed hinted at the prospect of scaling back its QE program. While today’s upheaval shares many similarities with that earlier event, there are also some notable differences.
As during the 2013 Taper Tantrum, investors worry that a further disorderly back-up in long bond yields (or an earlier-than-expected Fed tightening move) could undermine a still-fragile economic recovery marked by falling but elevated joblessness and below-target inflation. The Fed’s relaxed response to the recent rise in both long-term inflation expectations and bond yields—despite a sharp upgrade in growth forecasts—has added to uncertainties.
Recent sell-off has only brought bond yields back to 2013 lows
A very different macro and monetary policy backdrop
But economic conditions and the Fed policy framework are very different today than in 2013. While unnervingly swift, this recent repricing of inflation risk started off a significantly lower base, and after a far more devastating economic shock. US Treasury yields are only now approaching 2013 lows.
In the aftermath of the 2013 tantrum, government and corporate bond yields soon fell as the Bernanke Fed reaffirmed its commitment to maintaining QE for longer and did not start rising again until after the actual tapering began in late 2014. Today, in stark contrast, the Powell Fed has shown no intention of adjusting the $120 billion monthly bond-buying program or backing off from its new, more inflation-tolerant inflation policy regime.
Patient Fed vs hawkish bond-market expectations
Yet, bond markets are clearly dubious about the Fed’s resolve. While market-implied rate expectations are closely aligned with the Fed’s median dot-plot projections for this year, they are now pricing in an earlier and bigger hike than even just a few weeks ago (see chart below). This contrasts with the FOMC timeline, which does not foresee raising rates until at least early 2024.
Fed-funds futures rates vs latest Fed dot-plot projections
Equities and bonds are diversifying again
Equities have remained relatively buoyant despite recent bond-market ructions, leading return correlations between the two asset classes to turn negatively correlated again – after a decade of moving in unison with the onset of the Global Financial Crisis (GFC) and extraordinary central-bank policy interventions. The recent turnaround restores the inherent diversification benefits of a balanced asset allocation in place during the pre-GFC decade and historically.
Return correlations of Russell 1000 vs US government 10-year bonds
Global markets are likely to remain volatile as investors recalibrate positions to the very different macro environment and Fed policy regime unfolding in 2021 and beyond.
This article first appeared on March 24 on the FTSE-Russell blog.
Photo Credit: Pictures of Money via Flickr Creative Commons
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