As the economy continues to recover economists and financial media have become increasingly antsy over the prospect of central banks tapering bond purchases. We fully expect Powell and ultimately Lagarde to provide warnings at least six months ahead of implementation. Treasury Secretary Yellen’s faux pas at a conference hosted by the Atlantic on Tuesday clearly rattled markets even though participants should know better:
It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy.
Since the aftermath of the “taper tantrum”, central banks officials’ utterances about tapering have been increasingly rare. The first chart measures discussion of tapering since 2013 in official speeches spanning over one hundred of the world’s central banks. Tapering discussions have increased slightly since the beginning of 2021, but not significant enough to worry over.
Nonetheless, investors have been working under a more hastened timeframe. Rate volatility expectations remain substantially higher looking into 2024. In addition, expectations looking into 2023 signal hedging against sooner than professed rate hikes by the Federal Reserve. All in all, markets are bracing for tapering talk between late summer this year (Jackson Hole?!) and sometime in 2022.
We have noted the Federal Reserve stands out as extremely passive in its language relative to history. Officials have adopted a results-based approach requiring strings of economic progress before lifting their fingers. The chart below shows the loudening lullabies officials have been signing to soothe investors’ expectations. A reversal in passive banter could be a strong indication that central banks are going to take hold of the wheel and diminish the rate of U.S. Treasury purchases.
On the other hand, the Federal Reserve appears increasingly divided under the surface. Words of agreement in Fed communications have declined in recent months as inflation has become a bigger concern. Accompanied by fewer invocations of “transitory” and a decrease in passive language, this would signal impending tapering and rate hikes, but we are not yet there.
Finally, the chart below shows the average path of U.S. 3-month yields into and after 50% of economies producing above-trend composite leading indicators (i.e. OECD CLIs). Nearly all global recoveries since 1960 saw short-end rates appreciably climb from this point in the cycle, but the current recovery has proven different. This is undoubtedly tied to the trend above, and we do not expect to see much change without a dramatic shift in Fed speech. Tapering and rate hikes are undoubtedly on the distant horizon, but we are likely to see indications in central bank communications well before then.