Portfolio managers assess impact on government bonds and question how stimulus will be paid back?
Investors should be mindful of a “taper tantrum 2.0 type moment” when the Fed stars pulling away from its huge stimulus package.
That’s the view of Sam Acton, portfolio manager at Picton Mahoney, who said this could start to happen 12-14 months from now, stirring feelings of dread and memories of 2013.
Bond market panic sparked a spike in U.S. Treasury yields seven years ago after investors learned that the Federal Reserve was slowly putting the breaks on its quantitative easing (QE) program.
Policymakers unveiled their plan for winding QE at the end of that year, but not before then-Fed chief Ben Bernanke triggered the “taper tantrum” when he revealed their intentions during an appearance before Congress in May 2013.
Acton said: “When you think back to 2013, the first hint of the Fed pulling away the stimulus and just how much of an impact it had on markets, rates going up and spreads, it's just a nasty combination for everything in fixed income.
“Fast forward to today, the size and scale of the stimulus programs are so massive and it's doing so much to support the markets. If and when the economy is back to normal, the Fed has to at least signal this at some point.
“When that comes, I think there's going to be a lot of volatility, so that's what I'm keeping in the back of my mind. It's not something that I'm worried about near term, but it's something that is inevitable.”
Phil Mesman, head of fixed income at Picton Mahoney, said it makes sense, therefore, for advisors to really understand the risks in your fixed-income portfolio, especially given the rally we've had, and how that has impacted government bonds and the credit markets.
He added: “Government bonds can’t deliver at these low yields and by deliver, I mean provide that insurance benefit to your portfolio. Having a review, or what I like to call a post-op assessment of what you have in your portfolio makes a lot of sense.
“Our current presentation that we're just finishing up is called Review, Reckon and Rebalance. And that is, review what we've seen within fixed income, have a reckoning and calculation on all that, and then provide some rebalancing considerations that extends beyond just our strategy.”
One big elephant in the room remains how the government is going to pay for all this stimulus. Ashley Kay, strategist, said it’s an interesting challenge made more complicated by the possibility of a leadership change in U.S. politics. But he said there is, essentially, only two possible ways that our leaders can do this.
“One of them is actually create inflation,” he said. “Creating inflation in the marketplace, which actually adds to nominal GDP growth, would actually create effectively faster growth at the end of the day as the percentage of debt to GDP goes down. The other way is to effectively tax, and there is talk of reversing this corporate tax from 21% to 28%. Prior to being 21%, it was 35%.
“There are all kinds of other potential ways that you can change taxes. But the issue that they may have with the tax regime is the longer that this crisis goes on, people get more used to being given money.
“I don't think in the first year of a Democratic government, for example, you'll see a lot of taxes to pay down the debt. Austerity, obviously, is something that they tried in Europe and created a lot of slow growth for a long time until they brought down their budget deficit.
“Eventually I think you tax and in the meantime you create really as much inflation as you can to add to growth. That's the longer-term call and governments have to come to a reckoning.”