Asset managers outline Fed tapering expectations ahead of Jackson Hole conference

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Asset managers are divided over the possibility of the US central bank announcing bond tapering at the Jackson Hole conference this week.

Investors are awaiting a speech from Federal Reserve chair Jerome Powell at the annual economic policy conference on Friday, during which discussions around tapering and interest rate hikes are likely to impact markets.

Alan Levenson, chief US economist at asset manager T Rowe Price, believes that Powell’s speech will not contain any “big surprises”. 

The central bank’s asset purchases are currently set at USD120 billion per month in Treasury bonds and mortgage-backed securities. 

Levenson notes that policymakers have indicated tapering is “likely to commence later this year or early in 2022”, conditional on developments in the US economy.

The latest meeting of Federal Reserve’s policy committee, FOMC, in July, saw discussions of trimming bond-buying gradually from later this year. 

“The FOMC has committed to providing ‘advance notice’ before making any changes to the Fed’s asset purchases,” says Levenson.

“In my view, ‘advance notice’ will come at the conclusion of the 22 September FOMC meeting, followed by the formal announcement on 3 November that the pace of asset purchases will be reduced in December – assuming the labour market recovery continues to meet the Fed’s expectations,” says Levenson. 

Most investors are expecting the US central bank to signal tapering of its asset purchases by the end of the year, according to a monthly survey of fund managers by Bank of America in August.

More than a quarter, 28 per cent, of fund managers believe the announcement will be made at the Jackson Hole conference, while 33 per cent predict tapering will be announced at September’s meeting of the FOMC, and another 23 per cent say it will come in the fourth quarter of 2021. 

Gero Jung, chief economist at Mirabaud Asset Management, believes that tapering is “likely” to begin later this year, but like Levenson, does not expect to hear details until September’s FOMC meeting. 

The Jackson Hole conference is instead likely to deliver “some hints on the QE tapering issue with some dovish cushioning”, according to Jung.

“We do not expect an official announcement later this week, with Powell more likely to acknowledge the strength of the most recent employment reports, while cautioning against the impact of the delta variant on economic activity,” says Jung. 

Jung also emphasises that “lowering asset purchases or tapering is NOT quantitative tightening”, as the Fed’s balance sheet will continue to grow throughout this year.

Vontobel’s head of Corporate Bonds, Mondher Bettaieb-Loriot, says the Fed is “unlikely to consider reducing asset purchases unless the labour market manages to achieve broad-based and inclusive gains”.

The Fed has said it will support the economy until its goals of full employment and inflation at the rate of 2 per cent in the longer term are achieved. 

“Markets could end up surprised about the Fed continuing its asset purchases until actual broad-based gains in employment are fully achieved. This is because markets tend to focus on aggregate measures which makes them think the Fed will start tapering in the relatively near term,” says Bettaieb-Loriot. 

Data from July shows the US labour unemployment rate dropped to 5.4 per cent, its lowest level since the start of the pandemic, easing recent worker shortages.

Bettaieb-Loriot continues: “Given this backdrop, tapering asset purchases might well be talked about at this year’s symposium but not actioned upon until well sometime in 2022, especially given Powell’s discussions on low employment and inflation in March 2021: 'we had low unemployment in 2018, 2019 and the beginning of 2020 without troubling inflation at all’. This could motivate him to slightly delay tapering to ensure that the recovery in employment is more even on a more definite basis.”

The Jackson Hole symposium could also change market expectations for interest rates in the medium-term.

Mirabaud’s Jung notes that Fed funds futures are currently pricing in two 25 basis-point rate hikes through the end of 2023, with a first rate hike near February 2023.

“Any signals on possible changes in Fed policy might have an even more important market impact than the issue on the specific timing on tapering QE,” says Jung.

However, T. Rowe Price’s Levenson also warns that the Fed starting to taper asset purchases “does not start the clock on a date-dependent countdown to interest rate lift-off”. “The latter has its own criteria,” he says. 

“If Powell wants to nurture the expectation that there will be an interval of, say, several months between the cessation of asset purchases and the first rate hike, he will not dwell on upside risks to the inflation outlook – though policy makers have acknowledged the balance of risks leans to the upside,” he concludes.

According to Nordea Asset Management’s senior macro strategist, Sebastien Galy, the Fed’s timeline for raising interest rates is likely to make the greatest impact on markets. 

“The announcement of tapering is unlikely to create a large shock in the market, though the US Treasury curve should eventually steepen again. The market simply had a long time to prepare for tapering,” says Galy. “The real shock will come when the debate on a cycle of Fed rate hike starts.”

Tightening could squeeze the valuations of growth stocks, leading to a large dispersion within the investment style, says Galy. 

“Tapering and Fed expectations of raising rates could be an issue for growth style equities and US Treasuries, at a time when companies have increased their leverage and many asset classes are expensive,” he says. 

“Once the cost of risk starts to increase significantly, some investment styles such as growth are more likely to find moments when they question their economic assumptions as the risk/reward deteriorates and the cost of leverage increases.” 

Galy says that that this is “unlikely to happen before 2022”, and will depend on inflation, and how much of it turns out to be “transitory”. 

Current levels of US consumer prices inflation, which reached a 13-year high in July, have been described as transitory by Fed officials, who point to supply chain issues and pent-up consumer demand.

“We continue to prefer solutions such as North American equities and multi-asset solutions which offer a diversification across style and offer flexibility,” says Galy.

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