We had the pleasure to interview Esty Dwek, Head of Global Market Strategies at Natixis IM ahead to the Jackson Holes symposium taking part tomorrow, where she has talked about how she is preparing for the Fed Taper, volatility of the markets and portfolio allocations.
How are you preparing/have prepared for the Fed taper? How have you changed the allocation of your assets in light of that, and when did you make those investment decisions?
We have not changed our allocation for tapering as we believe it is already expected and priced and will have only a limited impact on markets. Rate hikes are what matter.
When do you expect the taper announcement and at what pace do you expect the Fed to taper (the purchases of mortgage backed securities and Treasuries are proceeding at $120b a month right now)
We expect tapering to be announced in November and started in 2022 as uncertainty surrounding the delta variant will delay the “early tapering” that could have been announced in September and started in December. Probably at a reduction of USD15 billion per month.
Will volatility go up across markets even if only briefly and are there signs of people positioning for that?
No, we do not expect any major market reaction and we see little of positioning for this.
Looking back at the 2013/2014 taper episode, what lessons does that period have for us today; how is it similar and how is the current pandemic context different.
We are in a very different situation from 2013. First, the 2013 announcement caught everyone by surprise as “QE infinity” had been announced only a few before. Second, the economy was much more sluggish in 2013n than it is today. Today, the US economy is strong and does not need USD120 billion of monthly liquidity injections. Finally, not surprising the markets is key, and the Fed has been very good at laying the groundwork and forewarning us about tapering. As such, when does not matter so much, we know it is happening and we know it makes sense.
If markets are going to be resilient to the taper, then why — how can they withstand the withdrawal of $120b of monthly liquidity injections? Is liquidity actually already tightening, is there not a risk of a pandemic policy error?
Markets do not need this much liquidity given the underlying strength of the US economy. In addition, Treasury issuance is set to drop sharply in 2022, so there will be much less supply in the market. Also, financial conditions have actually loosened further in recent months, not tightened so there is plenty of room for tapering.
Is the real risk not the taper but Fed rate hikes — Do you expect the latter and when?
Yes! Markets react to interest rate hikes much more than tapering. And we expect a pause between tapering and the first hike, suggesting liftoff in 2023 and not before. Moreover, since we are not yet done with the pandemic and growth will soften into 2022, rate hike conversation are very premature at point. So much can happen in 2022 to alter the currently expected path.