Waiting for Fed's Taper to Start? You May Have Missed It

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ben Bernanke
Jacquelyn Martin/APFederal Reserve Chairman Ben Bernanke.
By Jeff Cox

Investors avidly awaiting signs that the Federal Reserve is ready to reduce its monthly stimulus may find that the news already has passed them by.

Tapering, as the market calls it, easily has been the market's main concern, and in fact only worry other than sustaining the modest growth in both earnings and gross domestic product.

That worry began in May of this year when Fed Chairman Ben Bernanke first raised the prospect during a congressional hearing, and speculation over when it may start has been a major market-mover throughout.

The Fed has been creating $85 billion a month that it uses to buy Treasurys and mortgage-backed securities, expanding its balance sheet to just shy of $4 trillion, in what is known as quantitative easing, or QE. It also has kept its target funds rate near zero since the financial crisis hit in 2008.

There's reason to believe, though, that the reduction in the pace of monthly bond purchases -- and that's all it will be, a reduction, not a cessation -- already has been mostly priced into market action and may not have such a monumental impact as is feared.

"Tapering may be a concern, but there are reasons why it may not be as much of one as many expect," Citigroup (C) credit analysts said in a report for clients. "In fact, we have seen signs in recent trading that U.S. credit may be fairly immune to tapering headlines."

"Immune" may be a bit strong considering that the market almost always has some reaction to Fed statements, however benign or substantial.

But recent rate movement suggests that while yields may well go higher,
the yield curve -- or the difference between rates of different maturities -- shows that the market may already have had its big reaction to tapering.

Almost immediately after Bernanke's initial tapering speech, the curve for investment-grade and the benchmark 10-year Treasury note jumped 0.8 percentage points while high yield rose 2.8 percentage points.

But the Citi team pointed out that spreads stayed stable during the most recent tapering scare as economic data improved in early December.

"One of our basic [tenets] is that the markets are efficient ... maybe not perfectly, but at least reasonably," Citi said. "In this regard, it's important not to forget that the QE tapering topic has been in the news for over six months."

There are also two significant facts worth remembering about tapering:

  1. The Fed has had ample supply for its operations since the government doubled the national debt over the past five years to more than $15 trillion. That is changing, though, with the lowest amount of debt issuance, at just over $2 trillion, a low since Lehman Brothers collapsed in September 2008.
  2. Government debt maturity is likely to be at its highest level ever at $1.4 trillion.
Investors, then, may want to look beyond the headlines and knee-jerk market reaction when weighing the true substance of QE reductions.

"QE is obviously a huge source of direct demand in the rates space, and a large indirect source elsewhere. All else equal when tapering takes place demand in the rates markets will fall sharply, and of course a spillover effect will be felt among risk assets," Citi said. "But all else is not equal."


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croone22

I guess everyone understands what the slippery slope is all about...It's the Fed's near zero interest rate policy that the Fed has put in place for what I call the Obamascam, creating a lot of stimulus money that is really 'fool's gold". Because the real math sloop will tell you that as inerest rise, the y dependent variable will be a very steep slope: x being the increase in interest rates and the y being the exponential change in inflation. I guess, like Obamacare, the vast majority of Americans will just have to wait until it happens to find out just how bad it is going to be. And that's America's problem,Presidect Obama just can't do the math, and is hoping that somehow the nation survives until he can retire to his shangrila and blame George W Bush for it all. Good luck America,you're going to need it.

December 07 2013 at 2:07 PM Report abuse +2 rate up rate down Reply
1 reply to croone22's comment
betty_brock

So true. The liberals are too dumb to see it.

December 07 2013 at 10:20 PM Report abuse +1 rate up rate down Reply
vlady1000

Do not try to reason it all out, just take advantage (financially speaking) of what they do, or do not do.

December 06 2013 at 11:47 PM Report abuse +1 rate up rate down Reply
betty_brock

FIRE THE FED

December 06 2013 at 4:57 PM Report abuse +2 rate up rate down Reply