Taper Tantrum

Furgeson Wellman by Brad Houle, CFA Senior Vice President

The sell-off in virtually all financial markets and asset classes preceding and following the Federal Reserve meeting and press conference this week has been dubbed the “Taper Tantrum” in the press. Investors and the media parsed and analyzed every syllable uttered by Federal Reserve Chairman Ben Bernanke during Wednesday’s meeting.

While nothing really changed in the message that the Federal Reserve Chairman delivered … the markets took it as an opportunity to overreact. The passing of time has merely brought us closer to the Federal Reserve’s previously announced subtle change in strategy as the economy has improved. The good news about “The Taper” is that it is clearly and acknowledgement that the economy is actually recovering. We do not believe that conditions exist for interest rates to move up sharply. Both the current rate of inflation and the projected future rate of inflation remains contained. Further, the tepid current economic growth does not seem poised to increase so rapidly that would cause the Federal Reserve to be forced to raise rates.

Fear of sharply rising interest rates and a bear market in bonds seem overblown. Interest rates are artificially low based upon the Fed’s bond purchase, however; if the purchases are curtailed, rates should seek a higher equilibrium but are unlikely to explode higher. If rates move slowly higher over the next two-to-three years, investors will have disappointing bond returns. The silver lining is the opportunity to reinvest at higher rates. Time is a bond investor’s friend in a rising rate environment. Also, it is advantageous for investors to own individual bonds and use active management in this type of environment. Many investors will welcome the end of the “tax on savers” that has been a consequence of zero interest rate policy. 

Equities that are viewed as interest rate sensitive have sold off the most during this correction. REITs and utilities have been notable underperformers. It is important to remember that most equity indexes are up nearly 12 percent for 2013. The equity markets probably got a bit ahead of themselves and were due for a normal correction. We still view the economy as being stronger in the second half of 2013 and equity markets should find a firmer footing when this myopic view of the “The Taper” has passed.

Our Takeaways for the Week

  • Nothing has really changed relative to the Federal Reserve announcement this week and the financial markets seem to be overreacting to the situation