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Taper Talk

August 21, 2013

Quantitative Easing (QE) is not anything new: it is the most recent asset purchase program undertaken by the Federal Reserve in an attempt to help jump start the economy after the financial crisis of 2007-2008. The programs most current form is the purchase of $85 billion a month of U.S. government bonds – this has led to a virtually endless stream of debate and arguments regarding the merits of the program and whether or not this has helped or hindered the U.S. economic recover.

We, however, are going to take a look at some of the impact that “taper talk,” or statements by Ben Bernanke that indicate a gradual reduction in the amount of assets purchased monthly, has been having on both the domestic market and international markets. The first place to start is the yield on U.S. debt securities: the 10 – year bond is yielding approximately 2.80%, which while not extraordinarily high in absolute terms, is much higher than it had been and on a relative basis. This is at least partially due to the “taper talk.” When bond yields increase the value of the underlying bond deceases in a process known as discounting: in order to generate the same return for the investor the bond has to have a higher yield. Bond prices and yields are inversely related, i.e. when one increases the other decreases. In addition to this impact on government debt, there have been significant outflows from bond funds in the wake of taper talk: even bond fund gurus such as Bill Gross and Jeff Gundlach have not escaped.

Moving to an international scale, the impending reduction of QE has led to sell offs in foreign equity markets, as well as the currencies of the affected nations. The correlation might not be as easy to see so let’s take a step back and examine it. With interest rates kept low, thanks partially to QE, U.S. investors and other investors looking to generate returns began to look internationally and into riskier investments. The combination of the low returns available domestically and the extra liquidity provided by QE made these riskier investments not look as risky – funds flowed into emerging markets and investments. With the talk of drawing down QE, and rising rates, these emerging markets have suffered significant losses: currencies have not been exempt either, with the rupee, rupiah, and lira all making headlines in the last several weeks.

This goes to show, once again, just how interconnected the global economy is and the variety of factors that can impact your investments. Interestingly enough, the unsettlement in international markets has led some to believe there will be an increase in demand for U.S. government debt, which would push yields down again.

This is just scratching the surface of the issue, so feel free to let me know if you want more discussions on this!

Happy Reading!

http://www.cnbc.com/id/100978883
http://money.cnn.com/2013/08/21/news/economy/federal-reserve-minutes/
http://online.wsj.com/article/SB10001424127887324165204579026262361682396.html
http://www.marketwatch.com/story/bond-fund-august-outflows-hit-303-bln-trimtabs-2013-08-21?link=MW_latest_news

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