A Tale of Two Tantrums

November 17, 2016

A Tale of Two Tantrums Photo

U.S. interest rates have been trending higher since July and gathered additional steam following last week’s surprising (especially to the pollsters) election results. However, despite the dramatic spike post-election, the increase in rates so far has yet to catch up with the move experienced during the taper tantrum in 2013. The 2016 version of the taper tantrum started in July, when the Bank of Japan (BOJ) and European Central Bank (ECB) suggested extraordinary monetary policy stimulus in the form of negative interest rates and quantitative easing was reaching its limits.

The 2013 and 2016 taper tantrum episodes have obvious similarities in terms of interest rate moves, but differ in other respects. In 2013, corporate credit spreads gapped wider and equity prices dropped immediately after Ben Bernanke suggested the Federal Reserve (Fed) could soon begin reducing the size of bond purchases as part of its latest quantitative easing program (QE3). Weakness in corporate credit and equity prices, however, proved short-lived and both markets recovered strongly after mid- 2013. Despite the dramatic rate increase in 2013, the S&P 500 Index posted its best performance post- crisis,  up more than 30%. In contrast, performance for equity and credit markets since July of this year has been steady, but not spectacular. However, the risk markets have recovered sharply from the lows set on election night.

The change in investor inflation expectations, as measured by comparing yields on 10-year nominal Treasury bond yields with 10-year Treasury Inflation Protected security yields, represents another notable difference. Inflation expectations fell throughout 2013 despite the back-up in rates. Inflation expectations have increased this year and moved sharply higher post-election. The potential for more expansionary fiscal policy under the Trump administration helps to explain the opposite reactions. Investors in 2013 were more focused on a looming federal government shutdown as opposed to the potential for tax cuts and new infrastructure spending.

Key Takeaway:

More than $1 trillion in value has been wiped out across the global bond markets since last week’s election. Despite the dramatic bond market sell-off, interest rates in the U.S. are only back to the point where rates started in January. The trillion dollar question now: What does the recent rate move mean for interest rates looking forward? Whether it is the death of the 30-year bond bull market or just an extended period of hibernation, we expect disappointing returns from the interest rate sensitive segments of the fixed income markets into next year.

Tags: Chart of the Week | Bonds | U.S. economy | Federal Reserve | Interest Rate

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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