The US Fed’s looming tapering – and how will you be placed when it starts?
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MR MARKET is now more often than not spooked by the word “taper”.
Since the start of the coronavirus pandemic last year, the Federal Reserve Bank (Fed) supported the US economy. Interest rates were slashed to near zero percent while the Fed is purchasing $120 billion (R1.8 trillion) of government bonds monthly.
The economy has recovered to such an extent that the Fed is considering tapering of these asset purchases.
On Friday, Cleveland Federal Reserve Bank president Loretta Mester said the Fed should start reducing its support for the economy in November and could start raising interest rates by the end of next year.
Tapering of asset purchases, specifically of long-term bonds, is likely to lead to rising long-term interest rates and therefore to a steepening of the yield curve in the US.
On the other hand, hikes in short-term interest rates lead to a flattening of the yield curve as weaker economic growth and lower inflation are reflected in long-term interest rates rising at a slower pace than short-term interest rates.
In my opinion, it appears that the Fed is modelling its monetary policy based on the experience following the global financial crisis in 2008/09.
Mester’s suggestion to start tapering in November will be 21 months from the start of the coronavirus pandemic last year.
I was astounded to find that the US yield curve also bottomed exactly 21 months after the worst market levels during the global financial crisis in 2008/09.
Raising interest rates by the end of next year will be about 32 months from the start of the coronavirus pandemic and coincides with the start of the yield curve’s downward slope 32 months after the worst market levels during the global financial crisis.
If Mester’s suggestions realise and the US yield curve follows the post 2008/09 crisis trend through end-2022, it is possible to get a feel for the development of the US economy and financial markets over the next 15 months based on the trends post the 2008/09 global financial crisis.
Here is my take on it.
US economic growth is likely to weaken slightly in the fourth quarter this year, but will gain traction again through to the end of 2022.
US manufacturing PMI is likely to moderate to about 55 points in November from 60 points, but will resume an upward trend in 2022.
Capacity utilisation is likely to level off at 76 percent until November but will increase gradually to 80 percent – seen as full capacity – by the end of 2022.
Year-on-year growth in industrial production is likely to slow to about 4percent in the fourth quarter of this year from 6.5 percent currently, but could exceed 5percent next year.
Consumer confidence is likely to contract further in the last quarter of this year, but will rebound strongly until the third quarter next year ditto employment.
The US consumer price inflation rate is likely to drop sharply in the fourth quarter of this year but will resume a strong upward trend in the second quarter of 2022.
US stock market volatility is likely to remain somewhat elevated until November this year, but the CBOE VIX (volatility index) is likely to decline gradually to investor complacency levels of below 12 over the next 12 months.
The US stock market as measured by the S&P 500 Index is likely to come under further downside pressure as valuations as measured by the Shiller PE10 is likely to come under pressure over the next few months.
A strong recovery in stock prices can be expected in the first quarter of 2022 and is likely to last to the third quarter of the year.
The same can be said for developed market equities in general as measured by the MSCI World Index in US dollar.
The S&P 500 Index is likely to perform in line with the developed market equities universe in US dollar, while the Nasdaq Index is likely to outperform.
Commodity prices, especially metal prices as measured by the Economist Metals Index in terms of US dollar as well as gold, are likely to extend the downward trend through to the end of this year but will stage a strong recovery in the first half of next year. The second half of 2022 may see the start of new bear markets in commodities.
Emerging market equities as measured by the MSCI Emerging Market Index in US dollar are likely to decline further until the end of this year, but a strong recovery is expected in the first quarter of next year. Emerging market equities are likely to underperform developed market equities.
Global value stocks are likely to continue to underperform the developed market equities universe through end-2022, while growth stocks will continue to outperform the said universe.
Consumer staples stocks are likely to outperform the MSCI World Index in US dollar through to end of this year, but underperform in the ensuing two quarters.
Consumer discretionary stocks are expected to continue to outperform the developed market equities universe through end-2022.
The US dollar is about to peak and will soon start the down trend that could take it down by more than 15 percent by end-2022.
Yes, the ghost of a Black Swan is spooking Mr Market.
The next few months will be uncomfortable for investors and fund managers alike, but the global upswing is now seriously under way and will not be threatened by the tapering.
That is, unless some other black swan hits town. Be prepared for great opportunities that may present themselves when the tapering starts.
Ryk de Klerk is analyst-at-large. Contact [email protected] He is not a registered financial adviser and his views expressed above are his own. You should consult your broker and/or investment adviser for advice.
*The views expressed here are not necessarily those of IOL or of title sites.