Are investors going to throw a tantrum?

A few commentators have recently mentioned the risk that share and bond prices, as well as property values to a lesser extent, could take a knock if the world’s large central banks start to reduce the repurchase of bonds. This could have a profound effect on South Africa, as has happened in the past.

The central bank policy of quantitative easing fuelled the very strong run in bonds and share prices over the past year when governments acted to reduce the economic impact of the coronavirus pandemic, but this easing will eventually come to an end.

The last time central banks, led by the US Federal Reserve, cut the repurchase of bonds in the open market, investors fled bonds and shares fast – a move that earned its own moniker, the Taper Tantrum.

The phenomenon was first described after central banks started to reduce the repurchase of bonds in 2013 following five years of huge programmes of quantitative easing after the 2009 financial crisis.

The Taper Tantrum is again turning into a topic of conversation and even earned its own time slot at an investment seminar this week, when international asset manager Schroders identified it as one of the key risks in 2021.

Kondi Nkosi, Schroders country head for SA, says some investors and economists who are looking at market risks after the Covid-19 pandemic are expecting a sequel to the 2013 Taper Tantrum.

“This sequel could even be coming to [trading] screens near you in 2021,” quips Nkosi.

The original Taper Tantrum is seen as the period of market volatility in 2013 when the cheap money that was chasing expensive assets eventually ran out.

When the whole world’s financial sector teetered on the brink of collapse in 2009, the then-chair of the US Fed Ben Bernanke introduced its now well-known policy of quantitative easing.

This involved buying up large amounts of bonds and other securities, with the goal of increasing liquidity and stabilising the financial system by encouraging lending.

“This was supposed to stimulate economic growth by reducing the cost of borrowing, getting consumers to spend and businesses to invest,” says Nkosi.

“The policy worked. Between 2008 and 2013 the Fed bought almost $2 trillion in US government bonds and other assets. Economies and investment markets recovered strongly.

“Arguably, quantitative easing worked too well, as investors came to rely on this massive market support. Then came the twist …”

Bernanke announced in 2013 that the Fed would, at some point, start to reduce the amount of asset purchases it was making. Tapering off quantitative easing had severe unintended consequences.

‘How not to script an exit strategy’

“The Fed chair learned an important lesson in how not to script an exit strategy,” says Nkosi. “Investors – spooked that the world’s largest buyer of bonds was apparently exiting stage left – reacted badly to his announcement.

“Investors immediately sold off US bonds and the value of the dollar shot up.”

Somebody compared this overreaction to an event that should have been expected as a childish tantrum and the name stuck.

Schroders noted that emerging markets suffered severely, particularly the “fragile five” of Brazil, India, Indonesia, Turkey and South Africa, as foreign capital was withdrawn and their currencies depreciated sharply.

Read: Resilience test awaits emerging markets unnerved by Treasuries

Taper Tantrum: How the Fragile Five’s currencies responded

Nkosi says there are several similarities between central bank monetary policies of 2009 and the current accommodating policies to counter the economic effects of the Covid-19 pandemic.

There is, however, one big difference this time.

Figures quoted by Schroders show that the level of support provided by governments and central banks around the globe since the pandemic swept the world dwarfs the stimulus packages that followed the 2009 crisis.

The US government alone had spent around $2.6 trillion on fiscal stimulus packages by October 2020 – in a period of less than a year. Most of this was accounted for by the Coronavirus Aid, Relief and Economic Security Act (Cares Act) which totalled around $2 trillion.

Meanwhile, the Fed has helped prop up bond markets through an even bigger quantitative easing programme than before. The Fed’s balance sheet has soared to $7 trillion.

The figures show the Fed has been buying $120 billion of bonds and mortgage-backed debt every month since June – totalling nearly $900 billion in a few months, compared to $2 trillion spread over five years the previous time around.

Big party, big hangover?

The economists at Schroders expect that the pace of quantitative easing will moderate significantly, to around $100 billion per quarter in 2022 compared with its current pace of $360 billion.

“As in 2013, anticipation of this may trigger another taper tantrum, causing US bond yields to spike higher and making investors more risk-averse,” says Nkosi. “Stock markets could fall and as investors pull back from funding risky assets, while borrowers [be it a government or a company] may be less able to meet their debt payments.”

The tightening in financial conditions for governments and companies may hurt growth as confidence takes a hit and expenditure is reined in.

Read: The same stimulus that rich countries lean on could worsen poor economies (Apr 2020)

In emerging markets, a ‘sudden stop’ and reversal of capital flows could cause currencies to depreciate sharply, forcing central banks to raise interest rates. The combination of foreign capital leaving and domestic demand declining would harm growth in emerging markets.

Consumer, business and investor confidence – that finicky, all-important emotion in determining economic activity – could take a hard hit.

However, David Rees, Schroders emerging markets economist, has a bit of good news for SA investors.

The situation in SA

“The good news for SA is that the economy is currently less vulnerable to an external shock such as a taper tantrum than it was in 2013,” says Rees.

“In May 2013, SA had a large current account deficit of about 6% of GDP which essentially means it was paying more for imports than it was receiving from its exports. The gap between imports and exports is funded almost entirely by short-term capital inflows, which can turn into outflows very rapidly.”

Rees says SA’s current account balance has actually moved into surplus during the Covid-19 crisis, although he points out that this is not necessarily a sign of particular strength given that the move into surplus has been due to a collapse in imports (thanks to the economic recession).

“The current account will move back into a deficit as the economy recovers and imports increase. But as things stand, the improvement in the current account means that SA is less vulnerable to a taper tantrum that it was in 2013,” says Rees.

He does however warn that the high participation of foreign investors in the SA bond market means SA won’t be immune to another external shock.

And he says it’s worth noting that Schroders currently only places a 10% probability of another taper tantrum.

“After all, lessons [should] have been learned from the original taper tantrum.”