Fears of another tantrum as Fed looks to taper

A ‘taper tantrum’ caused by the US Fed’s plan to start withdrawing stimulus is fast becoming the market focus after a simultaneous sell-off in bonds and equities.

A rise in real bond yields is potentially bad news for growth assets such as shares and commodities. Above, a trader works on the floor of the New York Stock Exchange. Picture: Bloomberg

A “taper tantrum” caused by the Fed’s plan to start withdrawing stimulus is fast becoming the main focus of financial markets after a simultaneous sell-off in bonds and equities.

Compounded by the US debt ceiling impasse and surging energy prices, the US 10-year bond yield rose from 1.3 per cent to 1.56 per cent after the FOMC statement last week said “a moderation in the pace of asset purchases may soon be warranted”, and Fed chair Jerome Powell added, “a gradual tapering process that concludes around the middle of next years is likely to be appropriate”.

Highly priced growth stocks have borne the brunt of the risk in bond yields so far, but it is threatened to become a “sell-off in everything” that has benefited from the Fed pumping $US120bn ($165bn) a month into global financial markets since the early days of the Covid-19 pandemic.

After the S&P 500 dived 2 per cent on Tuesday, Australia’s S&P/ASX 200 index hit a four-month low of 7145.7 points before closing down 1.1 per cent at 7196.7.

A 5.7 per cent fall from its record high of 7628.9 in August was the biggest pullback in a year.

High-flying crude oil prices also started to feel the effects of the Fed’s plan to taper.

West Texas crude oil futures fell 2 per cent to $US73.75 a barrel in Asia-Pacific trading after hitting a three-year high of $US75.45 this week as the European LNG crisis spilled over to other fossil fuels.

Macquarie equity strategist Matt Brooks says the Fed has “given advance warning of tapering”. Using the 2013 taper experience as a guide, he feels we have seen “the first catalyst for a rise in US real bond yields”. They are now up about nine basis points since the September meeting, slightly less than a 13-basis-point rise at a comparable point after a similar catalyst passed in 2013.

And whereas real bond yields normally fall when economic growth slows, this time they are set to rise because of Fed tapering, having a “counter-cyclical” effect on the US economy.

That’s potentially bad news for growth assets such as shares and commodities.

Of course, the Fed could delay a tapering in response to a market tantrum, as it did in 2013.

If senator Elizabeth Warren – who has called Powell “a dangerous man” – and other progressives within the US administra­tion get their way, President Joe Biden could decide to replace, rather than reappoint, Powell before his term ends in February next year.

A more dovish Fed chair – such as Lael Brainard – could be a game changer for US monetary policy.

But for now, the market must prepare for a rapid taper starting in November or December.

In 2013, US bond yields rose more than 120 basis points in the seven months between the advance warning and the formal ­announcement by the Fed of its decision to taper.

“A sharp rise in bond yields in the next one to two months raises the risk of a 2013-style taper tantrum which saw ASX stocks fall about 9 per cent in a month,” Brooks says.

He says the key difference this time is that the economic cycle is slowing (based on OECD leading indicators), the commodity cycle has probably peaked, and tapering should support a stronger US dollar.

“The expected rise in bond yields is policy-driven and counter-cyclical,” Brooks says.

“This creates cross-currents for stock selection, as the defensives you usually want in a slowing cycle could be more nega­tively impacted by the valuation headwinds from rising yields.”

Thus, while cheap stocks should be affected less by higher yields, they are likely to have above-average cyclical earnings risk from the expected downturn in economic growth and commodities.

In the 2013 taper tantrum, healthcare was the best sector, and mining was worst.

In looking for stocks that benefit from rising real yields, Brooks prefers stocks with a direct earnings link, like insurers, banks or Computershare, or where the cycle is supportive, like energy and the so-called “Covid losers”, such as travel stocks.

“Be wary of stocks with high historical correlations where this is driven by the cycle and the earnings cycle for that group has peaked,” Brooks says. “Some mining stocks might be an example given China’s slowdown.”

With bond yields already rising ahead of Fed tapering, Macquarie has come up with a basket of 10 of its “outperform”-rated stocks that are positively correlated to bond yields. They include Computershare, Insurance Australia Group, Suncorp, Link Administration, Woodside, Incitec Pivot, Qantas, Worley, Downer and Origin Energy.