What the Coming Fed Taper Means for Bonds and Stocks

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The solid economic recovery and easing of COVID restrictions lead means a tapering of QE is not far off. Inflation has fully recovered to pre-pandemic levels, and employment is improving rapidly. On top of that are whispers from within the Fed questioning financial stability given extreme asset valuations driven to some degree by excessive quantitative easing (QE).

Most importantly, various Fed members are starting to talk the taper talk

The eventual tapering of QE will foster a change in investor behaviors. This article focuses on bond yields and a few interest-rate-sensitive equity sectors to provide forward guidance on how fixed income and interest-rate-sensitive assets may perform in a tapering environment.

Talking taper

Jerome Powell repeatedly affirms the Fed "isn't even thinking about thinking about tapering." Of course, as chairman of the Fed, his opinions take precedence over those from other Fed members. Regardless, other Fed members are not entirely on the same page as Powell.

The following comments and headlines came out over the last month.

  • Bullard: “U.S. May be “Getting Close” to the Point Where Pandemic is Over, and Attention Could Trun to Post-Pandemic Monetary Policy.”
  • Fed President Lael Brainard: "Vulnerabilities associated with elevated risk appetite are rising." The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a repricing event."
  • Fed President Kaplan: "The Fed should start talking about tapering bond-buying soon."
  • Fed President Kaplan: "I am beginning to feel differently regarding the advantages and drawbacks of the Fed's QE purchases."
  • Fed President Rosengren: "The mortgage market probably doesn't need as much support now."
  • Treasury Secretary Janet Yellen, per Bloomberg: "It may be that interest rates will have to rise somewhat to make sure our economy doesn't overheat," Yellen said in an interview with the Atlantic recorded Monday that was broadcast on the web on Tuesday. "It could cause some very modest increases in interest rates."