Fed Tapering Of QE Is Not Tightening Of Policy - Yet - Says Asset Manager House

Tom Burroughes

23 December 2013

The central bank for the world’s largest economy may have signaled it will wind down, or “taper,” its program of quantitative easing next year - but that is far from moving towards tightening monetary policy, argues .

A few days ago, the US Federal Reserve stated it will being to reduce its QE program (buying bonds with freshly created money), amid signs that the US economy is robust enough to operate without the life-support machine of fresh money.

For months, economists and wealth managers have speculated on when, rather than if, QE will be wound down. Earlier in 2013, strong suggestions of such a move by Ben Bernanke, the outgoing Fed chairman, hit markets, particularly in the emerging economies that had previously profited from the availability of cheap money in search of yields. (Emerging markets have lagged their developed counterparts this year.)

“In line with our expectations, ‘Tapering did not mean tightening’. In our view, the most recent tapering announcement was orchestrated to maintain a stable market environment, and we expect the market to remain benign and favorable to both broader risk assets and emerging markets,” Thanos Papasavvas, strategist at Investec Asset Management, said in a note. Investec AM oversees around $107 billion of assets.

“Our view holds that expectations of tapering were already priced into the market and more importantly yields were at fairly valued levels. Emerging market local currency yields at 6.75 per cent were already at the upper end of the 6 – 7 per cent fair value range and 10-year US yields at 2.85 per cent were already close to their current 2.75 per cent fair value levels,” he said.

Actual monetary tightening, Papasavvas said, is two years away. To manage expectations, Bernanke and his successor, Janet Yellen, want to keep US 10-year bond yields at or near current fair value levels.

“A gradual upward trajectory is expected with 10yr US yields moving closer toward 3.25 per cent fair value in a year’s time,” he said.

“In our view, Bernanke first mentioned ‘tapering’ in May not because the US economy was overheating with inflationary pressures, but as a prerequisite for correcting market mispricing in fixed income markets. Acting as a prudent central banker, he acted `to take away the punch bowl just as the party gets going’, and doing so by pricking a potential speculative fixed income bubble created by hot money and non-dedicated flows into fixed income assets,” he added.

He concluded that Bernanke wanted to avoid former Fed Chairman Alan Greenspan’s alleged mistake where, having identified a bubble in 1996 and warning of "exuberance" in markets, failed to take any further action against the market momentum thus causing the bubble to continue growing until the eventual 1999 dot com crash.