The original ‘taper tantrum’ of 2013 refers to the slow reduction of additional liquidity that the US Federal Reserve injected into the economy through securities and asset purchases. They announced that they would slow their buying from USD 85 billion a month until it hit zero, after which they would stop the repurchase of the securities they had bought through the facility once they matured. Many outside markets were hit but particularly hard hit were the ‘fragile five’- India, Mexico, Turkey, Russia and Indonesia. In successive iterations other countries were designated the fragile five but the effect was felt disproportionately amongst the countries with weak current account balances and/ or skewed debt repayment obligations (heavy up-front amortisation schedules).
There is a fear that the announcement by the Federal Reserve to start tapering its USD 120 billion per month buying programme as early as this year could bring about a second taper tantrum that would upset the apple cart before a proper recovery has been able to take hold across the globe. The fears of a K-shaped recovery across the world is a big fear of many countries who have committed themselves to large spending programmes to keep their economies afloat in these lockdown times. But the world is a different place than it was 8 years ago and this is a completely different crisis.
The first and biggest difference- of course, is the nature of the crisis. As stated often enough in these articles: the world economy went into a self-imposed shutdown to combat a deadly virus that is still with us. There wasn’t any capital destruction that caused this situation as there was in 2008/9. Banks then were on critical life-support, having destroyed their capital and threatened to pull credit out of the system in order to fill the black-holes in their balance sheets. Governments stepped in with fresh emergency capital, liquidity for the system through Quantitative Easing and low rates. We only have two of those today; the latter two. That is critical.
Banks are much better capitalised this time around than they were then. They’ve been forced to ‘up’ their capital adequacy ratios with more transparent and liquid holdings and they’ve shed much of their riskier assets. Furthermore, there hasn’t been a deterioration of a significant asset class in their books this time around. So, the central banks only had to ensure the smooth transition of credit and also make sure that there were no blockages in liquidity. The last time banks did not extend credit but hoarded the liquidity for themselves to ensure they survived. Now, they have been looking at reflation trades- positions where they hope to capitalise on the restart of many economies post lockdown. That makes the likelihood of a taper tantrum much less likely.
The Federal Reserve has also been working in coordination with the other central banks right from the start. They set up FX swap lines early in March 2020 to ensure that there would be no dollar shortages when there was a panic flight to safety for example. There is still an element of coordination amongst the central banks as many are looking to lift rates and tighten the liquidity taps. And this is a cause of concern for some investors who see the risk that the nascent recovery will be hobbled by a premature tight money market. But, many asset managers seem to believe that inflation, the main area of concern for some of the central banks, will be transitory and there won’t be any follow-up rate hikes- especially in countries with anaemic growth. The EU has already hiked their inflation target to 2% from ‘under’ 2% to accommodate the space for growth oriented rate and liquidity policy. US investors are seen as likely to shrug off the tapering announcement but that may be because the US is already seeing healthy recovery signs: the US Labour Department has stated that there are currently 9.2 million job openings in the US- a position available for every job seeker. So, the expected improved results in company earnings may soon justify the elevated valuations.
But the fears of tapering may also be overstated: Fed officials say that substantial further progress on economic recovery “was generally seen as not yet having been met” even though they are ready to act if inflation or other risks materialise. This is a bit of an ambivalent statement. And even this marks them as one of the most hawkish central banks according to a report from the Commonwealth Bank of Australia to its clients. With regard to the tapering: it could be “somewhat earlier than they had anticipated”- earlier 2023, now a few votes for 2022 and some even for end 2021: by no means unanimous.
The ‘victims’ of the taper tantrum are- this time around, better positioned with stronger external balances and buffers, the investors in the Emerging Markets are lighter and less concentrated in their positioning and there is- as mentioned earlier, better synchronisation amongst the central banks with the US Federal Reserve; and the simple fact that markets have bigger things to worry about right now.
This sounds harsh but it must be remembered that easy liquidity and low rates are only facilitators. Higher rates and less liquidity are not impediments but just make the environment a little more challenging and the investors a bit more discerning. Of more concern to most investors now should be the US sponsored global reform that is targeting a common minimum corporate tax rate globally- along with the G20, trying to close loopholes that allow corporates to transfer profits across jurisdictions. The aim is to bolster government balance sheets that are taking on large burdens at this point in time but the effect is going to impact asset allocations across the globe. Also, let’s not forget that the pandemic is insistent on overstaying its welcome with the delta variant- the most transmissible variety yet, threatening to send everyone scurrying back indoors again and de-railing a return to normalcy one more time. This applies particularly to the unvaccinated emerging market nations. This is likely to have more of an impact than the US taper. Right now, most asset managers are being quoted as remaining Emerging Markets heavy still; taper talk is not dissuading them. New tax laws and the never-ending pandemic might.