The lack of clarity from the Federal Reserve (Fed) on when it will begin to withdraw stimulus to deal with the pandemic, at the same time as the U.S. bond yield continues to rally after months of steady increases - in the first days of January it has surpassed 1%, a level not seen since the beginning of the pandemic - has made many in the financial world resurrect the ghost of the 2013 'taper tantrum' as a real possibility for this 2021.
Remembering a bit of History
After several years of stimulus to get out of the great crisis of 2008, in 2013 the FED began to show its intentions to put the brakes on by putting on the table early reduction of its bond purchases, something known as 'tapering'. These statements triggered a rapid wave of bond selling among investors, with the consequent rise in yields and fall in prices.
This 'tantrum' of the markets in the face of the notorious threat that Ben Bernake, then president of the FED, would turn hawkish and reduce asset purchases, triggered volatility and caused sharp falls in the different exchange rates against the dollar and in the prices of bonds and stocks of emerging economies, which had benefited in previous years from an active global search for yields.
The following chart shows enclosed in the red box the period from the first week of May 2013 (tapering announcement) to early August, where the US bond price (Japanese candlesticks) fell sharply, as did the emerging markets (area chart) represented in this case by the EEM ETF:
This other chart also shows the effect of tapering on the USD/MXN currency pair, where the dollar strengthened to the detriment of the Mexican peso:
Actual Situation
The current scenario presents important similarities, especially as we are facing a scenario of an exit from a severe crisis with almost unprecedented levels of debt. For this reason, it is once again essential to know how the Fed will move and how it will manage a possible 'freeze' of its balance sheet.
Although Fed Chairman Jerome Powell reiterated this past Wednesday, February 24, that there are no plans to raise rates in the short term or any reason to alter the current expansionary policy, there is noise in the background at the Fed. Recent statements by some of its members have shown an incipient division between those who advocate reviewing the current pace of bond purchases at the end of 2021 - $120 billion per month ($80 billion in sovereign bonds and $40 billion in mortgage-backed assets) - and those who advocate making no change before 2022. These hesitations are causing bond investors to start acting suspiciously.
As will be seen, since the beginning of October 2020, bond sales have been increasingly accentuated, with three stages standing out:
- At first (gray arrow) as a consequence of the effectiveness of the vaccines in its phase 3 as it would mean a reactivation of the economy and therefore, the US bond was deactivated as a haven, for then,
- Early January 2021 (green arrow) with the victory of the two Democratic senators and the obtaining of a simple majority in the Senate, which meant an easier approval of an aid plan, to finally.
Early February 2021 (red arrow) with inflation expectations rising and the split among the members of the Open Market Committee on whether or not to continue the Fed's accommodative stance, returning the specter of the "Taper Tantrum"
The question is, how far can the U.S. bond fall? Well, the answer to that question can be found if we look at its very long-term performance as shown below in a chart of months:
AXL Capital plotted a downtrend line, joining the highs, starting from September 1987 to the current time, noting that it was respected at all times except for the end of 2018 when it violated it and remained above it for a few months, until returning below it. Note that if this dynamic continues, the U.S. bond yield currently at 1.45% has the potential to rise to 1.70% in the medium term, which portends further declines in the U.S. bond price.
There is also another way to see if the yield still has upside potential, and that is by comparing its yield to 5-year inflation expectations as shown below:
The blue line reflects 5-year inflation expectations which since the lows caused by the pandemic at the end of March 2020, has risen much more strongly than US bond yields (brown line) which remained for much of 2020 lagging in comparison, not being until the beginning of the fourth quarter of 2020 and especially since the beginning of 2021 that it goes in free ascent (the yield) in search of its meeting with expectations with which it usually coincides for most of the time and which we see still has some way to go.
But what is the reason for this strong recovery in inflation expectations that is subsequently causing a spike in yields causing something akin to the Taper Tantrum? The answer is somewhat complex, but one thing that has contributed to the rise is the increase in average hourly earnings year-over-year, which since the passage of the first fiscal stimulus package has risen sharply from its historical average:
It can be seen that the average earnings of private sector employees are increasing at an annualized rate of more than 5%, which explains why inflation expectations are high.
Relation of the bond to Gold
The previous analysis that has been done on the U.S. bond, is to explain in part the behavior of Gold over the last few months, as it has a strong correlation with the bond.
If we take into account the variables and events that have triggered the downtrend in the bond price, we will better understand what is happening in the medium term with Gold.
The following chart shows a weekly comparison of two ETF's, one that replicates US 20-30 year bonds (TLT) and the other that replicates Gold (GLD):
Firstly, the high correlation between both values (bond and Gold) and secondly, the red arrow points out the downtrend of the TLT (area chart) due to all the events already mentioned above and that to some extent are responsible for "pulling" down the price of Gold (candlestick chart).
If we take a closer look at the following chart (daily time frame) we will see again the downward trend of the bond (area chart) and how Gold follows it in its fall:
Technical Aspect of Gold
We have already indicated Gold's dependence on the performance of the U.S. bond, now we need to see in what range Gold could move in this situation and we can see that on a weekly chart:
At the moment, the underlying trend of Gold is bullish without any doubt, what has happened is that it has been using the last months to clear a strong overbought that accumulated when it was used as a haven asset when there were recent fears about the economic shutdowns.
If we look at the technical figure, AXL Capital visualizes a resistance at $1,860 and support at $1,705 is the break of the latter a signal to unwind positions in Gold as it would be a confirmation of the end of the bullish pattern presented by Gold so far, especially if we also rely on the strong correlation with the US bond that presents a downtrend, supported by the high inflation expectations already explained.
Conclusions
But, is there a risk of repeating a 'taper tantrum' like the one in 2013 when the US 10-year bond yield went from 1.6% to 3% in a few months? The key is to gauge the sensitivity of U.S. bonds to macroeconomic data that would be a positive or negative surprise.
Keep in mind that the Fed's inflation target is the last clue we have to know its forward guidance, which is to anchor nominal interest rates, even once GDP starts to recover with the global administration of vaccines. If this forward guidance is credible, it should prevent yields from rising on positive surprise data, because markets will believe that the Fed remains accommodative. But if markets begin to question this forward guidance from the Fed, these positive surprise data will matter.
To cite one example, the worse-than-expected January nonfarm payroll data show that the T-Note and 30-year bond yields, instead of falling, actually rose a bit. "The fact that longer-term yields moved higher suggests that markets see weak data as a catalyst for further fiscal stimulus," warning that such a reaction stokes the risk of a repeat of a 'taper tantrum' like 2013.
However, AXL Capital sees a higher probability of a genuine tantrum as a risk for 2022, not 2021.
In the coming days, we will analyze the Gold price projections in the econometric model for March 2021. Stay tuned!!!!
