The debate in financial markets these days is about when the US Federal Reserve will begin tapering its bond purchases. But most importantly for all assets from stocks to bonds and currencies, when will that end?

There were few major moves ahead of the Federal Reserve’s Jackson Hole virtual seminar in Kansas City, while a timetable could be set for how close the Fed will raise rates after Chairman Jerome Powell provided insight Friday into how and when officials will begin withdrawing market support. bonds.

The risks appear high with a large amount of liquidity flowing into the financial system, which pushed US stocks to record levels, while Treasury yields stabilized near their lowest levels in six months, and then the rapid decline in support may hinder the economic recovery significantly in The time when risks increase due to the spread of the mutated Delta strain.

In turn, moving too slowly could lead to more inflationary pressures that were unleashed with the reopening of activities that were closed due to the pandemic.

Rate Hike Timing

“The pace of the Fed’s reduction in support is the deciding factor for the markets, because that speed will determine the timing of completion, which will then result in determining the timing of the first rate hike,” said Tom Essay, a former Merrill Lynch trader and founder of The Seven newsletter. Benefit”.

The Federal Reserve buys $80 billion a month in Treasuries and $40 billion in mortgage-backed securities at the moment, and the Fed is expected to halt those purchases before it raises interest rates. The Fed said it would keep those purchases steady “until further tangible progress is made on meeting employment targets and stabilizing prices.”

It took 10 months before that when the Federal Reserve canceled a similar program of $85 billion a month following the last recession in the economy, as the cuts were announced in December 2013 to actually begin the following month with the Fed splitting those cuts by 10 Billions of dollars in each monetary policy meeting, and that value was divided equally between Treasuries and mortgage bonds, to end all purchases in October 2014, and return to raise interest rates in December 2015 after keeping them steady for seven years.

Taper Off

Essay sees tapering likely to start in December and continue through 2022, expecting this to support continued gains in stocks and commodities, and push the 10-year Treasury yield to 2%.

Money market traders are currently pricing financial assets, according to expectations that the Federal Reserve will raise interest rates for the first time during the first quarter of 2023, as the interbank financing interest rate will reach a peak of about 1.4%.

“When the Fed actually announces tapering has begun, it is likely to provide information about the pace, how long it will take, and whether or not the Fed is willing to deal with tapering,” said Junit Dingra, head of US interest rate strategy at Morgan Stanley.

“That could provide a key signal about the rate hike cycle, especially in terms of the pace of those hikes,” Dingra added.

Expectations of rising bond yields

10-year Treasury yields have fallen significantly since March, reaching 1.3%, approaching their lowest levels amid fears of renewed waves of the Corona epidemic in the United States, and their negative impact on the weak recovery.

This comes at a time when the gap between long- and short-term bond yields has narrowed since hitting a 5-year high last March, in a sign that the Federal Reserve will soon withdraw its stimulus programs.

The possibility of higher interest rates reinforced the gains of the US dollar, which rose this month to its highest level since last November, according to the “Bloomberg Spot Price Index for the Dollar”.

Morgan Stanley expects 10-year Treasury yields to reach 1.8% by the end of the year as the Federal Reserve begins tapering in January, which is expected to end in October. The bank also expected that the second quarter of 2023 will witness the first rate hike.

Stephen Barrow, head of G10 strategy at the Standard Banking Group, emphasized that there is greater risk if the Federal Reserve delays tapering than if it moved early.

The delay could force the Fed to raise interest rates within just months of ending its bond purchases, which could worry financial markets and reduce risk appetite, which could push investors into safe havens such as the Japanese yen and Swiss franc, Barrow said.

“It would be a risk if the Fed did that, because it would need to be, starting in the middle of next year — ready to announce the possibility of a rate hike, and we all know the possibility of the Fed raising rates sometime at the end of next year, so it has to be,” Barrow added. From focusing more on the timing of the end of the downsizing than the beginning.”

Bubbles everywhere

James Bullard, president of the St. Louis Federal Reserve, has expressed his desire to end tapering by the first quarter of 2022.

While Rafael Bostick of the Federal Reserve in Atlanta, said that the tapering should start after the announcement of a few strong jobs reports, and be completed at a faster pace than in previous times.

Many issues remain at stake until monetary policy returns to normal this time, as interest rates approach zero and accommodative monetary policy coincides with the debt burden rising to historical levels, and for near-record terms, which indicates the sensitivity of the bond market to changes in interest rates.

That risk extends to stocks, even tech stocks, which have surged after the pandemic. The cheap money pumped into markets worldwide pushed bond yields down and in search of higher yields, creating bubbles almost everywhere.

“Liquidity used to buy on margin is what matters to the markets, so the tapering off will affect other assets, from cryptocurrencies to some high-yield stocks and bonds,” said George Goncalves, head of US macro strategy at MUFG Securities America. More than their impact on Treasury bonds, so those securities must rely on themselves.”