Taper Tantrum 2.0
Inflation expectations and bond yields tend to track each other except for 2013, which happened to coincide with the taper announcement. I think we’re in for Taper tantrum 2.0 except potentially bigger.
Monetary policy expectations will be primary to the bond market here and I expect the 10 year yield to move higher with inflationary expectations declining as a result of a downturn in China’s economy and commodity prices.
The rise in 10 year bond yields shortly after the financial crisis was a result of rebounding inflation expectations, and by no means a result of tight Fed policy.
Fed policy around QE1 and 2 time was inarguably extremely accommodative, and bearish for REAL yields. QE policy pushed inflation expectations higher from the very low levels during the Financial Crisis and monetary policy expectations easier.
In 2013 when Bernanke announced a plan to taper asset purchases, yields rose despite falling inflation expectations. I expect a repeat.
With the current Fed policy being less accommodative and inflation expectations declining this equals rising expected real yields or rates. I believe the 10 year yield will move higher as a result of monetary policy but falling inflation expectations will provide support to bond prices.
The goal is to be preemptive on inflation as waiting risks an overshoot and a more abrupt tightening response which could prove recessionary.
Pushing real rates up a little while might elicit a response from the financial markets, and one must consider the spillover effects from financial markets to the economy. Though, it is in my opinion fairly benign to the real U.S. economy and any turbulence possibly stemming from China, oil prices and inflation expectations will be transitory. The Fed is set on tightening policy and won’t reverse or pause the minute there is any type of financial market disruption