As attention moves to the upcoming Jackson Hole Economic Symposium (aka global central bank meet up) it’s worth taking a look at a couple of developments in monetary policy and bonds markets.
The main reason, as I will explain, is that there is the very real prospect of a repeat of the “taper tantrum” of 2013… a Quantitative Tightening (QT) tantrum, if you would.
We looked at the issue in detail in the latest weekly report, alongside a preview of Jackson Hole – noting the key economic developments that point to a global trend-change in monetary policy.
The chart of interest is the US 10-year government bond yield (INDEXCBOE:TNX), shown alongside bond market implied volatility (or the ‘VIX’ of the bond market).
Bond market implied volatility has crunched back to levels last seen immediately prior to the 2013 taper tantrum. Similarly, speculative futures positioning is now stretched to the long side, and assets under management in income oriented funds have ballooned to record levels. So looking at the market alone, it feels vulnerable to a shock. That is, the bond market looks complacent and overbought.
Think then, about the prospect of the Federal Reserve announcing Quantitative Tightening (QT)… i.e. “balance sheet normalization”. The Fed announced plans for balance sheet normalization earlier this year, and with a couple of rate hikes now under its belt, the Fed will be looking to activate these plans, and September would be an ideal juncture – with Jackson Hole providing an ideal forum to discuss and flag its imminent arrival.
Something this well flagged you think wouldn’t upset markets too much, and the Federal Reserve has been consulting heavily with asset managers and financial market participants about its plans for balance sheet normalization. So on the face of it you wouldn’t expect any financial stability concerns… indeed, in the BAML fund manager survey, and our own surveys on Twitter, the majority of respondents expect QT to be either a non-event or even a risk-on catalyst.
So maybe Janet Yellen flags QT at Jackson Hole, and then maybe the FOMC pulls the trigger on it in September. And maybe the market shrugs it all off. But that last maybe seems the least likely. With a complacent and overbought bond market, and relaxed attitudes towards Fed balance sheet normalization, whether it’s Jackson Hole or the September FOMC, don’t count out the possibility of a QT tantrum. Also, if it happens it would come at a time where equity markets look vulnerable and the currency is at a key moment.
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.