Taper Nervous Breakdown

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The next time the Fed reduces its bond purchase program the market reaction should be more like a nervous breakdown rather than just a tantrum.

First, let’s review a bit of the historical histrionics surrounding the initial Taper Tantrum. Back in September 2012, the Fed’s Quantitative Easing program was running at the level of $85 billion per month. The asset purchase program consisted of both Mortgage-Backed Securities and Treasuries. Then, in December 2012, Fed Chair Ben Bernanke expanded his massive QE 3 scheme by making its duration unlimited. But by May 2013, the time had finally arrived to start discussing the tapering of its asset purchases. And in December of that year Tapering officially began; with QE ending by October 2014. Of course, the Fed would be back in the QE game six years later. But at the time, the overwhelming consensus thinking was that the 100-year economic storm had passed and we would never witness such extraordinary actions by our central bank ever again.

While the S&P 500 did drop by 5% in just a few weeks after Bernanke first discussed reducing asset purchases, the carnage was much worse in the sovereign debt market. In May 2013, after just a mere suggestion of an imminent reduction in bond purchases, panic spread throughout global bond markets. The 10-year U.S. Treasury took it especially hard, sending bond prices plunging. The Benchmark yield gained 140 basis points between May and early September 2013. According to PIMCO, the yield on the 10-year Note was 1.94% on May 13th, the day before Bernanke’s testimony. But less than four months later that yield surged to 3.34%.

As bad as that Tantrum was, there are three reasons why the next Taper Tantrum should make the previous markets’ hissy fit look like a state of tranquility.

The first difference is that the Fed is now buying $120 billion worth of assets each month instead of the $85 billion during QE 3. It was buying MBS and Treasuries during the runup to the last Taper Tantrum. But now, the Fed is not only buying those same types of assets, it has thrown in for the first time ever new types of debt including municipal and corporate bonds—even junk-rated debt—with its current QE 4 program. This humongous market distortion has forced bond yields much lower than they were seven years ago. Back in the Taper Tantrum days, the thought that there could ever be negative-yielding sovereign debt was absurd. Today, there is nearly $20 trillion worth of debt that offers a yield less than zero percent. Treasury bond yields are also at a record low—some one hundred basis points less than what existed in 2013. With bond yields so low, it simply means the potential energy stored up behind interest rate normalization will be all the more violent; with the rate of change causing G-LOC.

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Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called,  more

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