Taper Tantrum 2.0

The unnerving start to the year escalated this week, with many lay observers attributing market volatility to the rising possibility of war between Russia and Ukraine. But, while political tensions are not helping markets (nor energy prices), the heart of the market rout lays with the re-emerging determination of central banks to fight inflation through monetary tightening.

Markets are concerned central bankers, namely the US Federal Reserve (Fed) have veered from downplaying the inflation threat to overreacting, particularly now, when the economic temperature is coming back down on its own.

Readers may feel reminded of the market dynamics of the 2013 ‘Taper Tantrum’, when equity markets sold off markedly after the Fed announced its intentions to wind-down its quantitative easing (QE) policy by reducing the pace of US Treasury purchases – indicating the beginning of a monetary tightening cycle. Back then, the news caused a ‘tantum’ from bondholders, pushing up bond yields significantly, while equity markets recovered relatively quickly. If history repeats itself, it would therefore seem that the current bout of market volatility is nothing overtly unusual at this stage of the economic cycle, and unlikely to herald a poor year for investors after two surprisingly strong ones.

While this is broadly true and our central case, circumstances are, of course, never quite the same. We are in near-uncharted territory (a post-pandemic recovery period), while it is also worth noting central banks have not entered a tightening cycle with the expressed intention of bringing down inflation since the 1990s. (more recent tightening has been aimed at preventing inflation from reaching the levels they are already at today, and about central banks raising rates to re-establish rate cutting potential to fight later downturns).

Markets are, therefore, excused for being both jittery but uncertain over the most likely direction of travel, as this week’s wild swings evidenced. This drab and second COVID-restrained January certainly does focus minds on the negatives. Retail investors are understandably worried about preserving the gains made over the past two years, even if they never really quite understood the reasons behind those gains, given the global economy – and their life in general – never lived up to a similar level of positivity.

That there were almost as many buyers as sellers of risk assets this week points to certain cohorts of investors being willing to identify positives further ahead, and also willing to assume the Fed will resist being too single-minded in its inflation fight to inadvertently choke off the nascent recovery. We remain in pandemic times, but we are quite evidently approaching the point of exit. Those who disagree, will nevertheless have to admit that even at the height of the pandemic, springtime has always brought relief and a significant rebound of economic activity.

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This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note past performance is not reliable indicator to future returns. Your investment may fall as well as rise and you may not get back what you put in.