November 6, 2021

Taper Time


Bottom Line: 


Equity markets had another great week with major indexes rising approximately 2%. The Federal Reserve announced a policy decision that was heavily foreshadowed, but we will take some time to break down the shift and compare it to global central banks. The market may have appreciated the Fed’s predictability, but we also had a good jobs report with numbers bouncing back from Delta variant lulls. And maybe seasonality is now shifting from a headwind to a tailwind.


The Full Story:


I would be remiss if I didn’t close the loop on the Federal Reserve preview that I wrote last week. On Wednesday, as expected, the Federal Reserve’s Federal Open Market Committee (FOMC) announced the start of balance sheet tapering at a pace of $15 billion per month ($10 billion of U.S. Treasuries and $5 billion of mortgage-backed securities) beginning in mid-November. That’s a reduction from current purchases of $80 billion of U.S. Treasuries and $40 billion of MBS per month. Additionally, the committee voted to maintain the current Federal funds target interest rate at a range of 0.00% – 0.25%.


After tapering bond purchases in November and December, the statement noted that “the committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.” The language signifies that the FOMC could change the pace of purchases, if necessary, but the logical projection suggests the FOMC will conclude tapering in June 2022 and begin reinvesting maturing securities in order to keep the balance sheet level. It should be noted that tapering is not tightening, and while purchases are coming to an end in the months ahead, the balance sheet will still expand by roughly $400 billion from now until mid-2022 before settling at approximately $9 trillion.



Per the CME Group’s FedWatch tool, federal funds futures are now pricing the first interest rate hike occurring in July 2022 at roughly 63%, and a similar 62% probability of at least two hikes priced by year-end 2022. When Fed Chair Jerome Powell was pressed about the market having priced in two rate hikes in the second half of next year, he avoided the question and reiterated that the economy will dictate the trajectory of rate hikes and kept options open. Maybe the lack of endorsement by Powell of the market’s rate hike pricing explains the post-meeting rally in U.S. stocks, which moved into positive territory shortly after the release of the statement.


The FOMC statement added two new mentions of supply challenges that were not in September’s statement. Specifically, it noted that “inflation is elevated, largely reflecting factors that are expected to be transitory” and that “supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.” Powell also emphasized that because the FOMC expects supply chain disruptions to last into the first half of next year, a “clean” inflation reading that is not distorted by factors the FOMC views as largely out of its control (“the Fed’s tools cannot address supply chain constraints”) may not come until the second half of next year.


So, how does the U.S. Federal Reserve and new policy shift towards gradual tightening compare to other global central banks?


There are some central banks that are already hiking rates. This includes “high-yielding” emerging market central banks that have low policy credibility because of a history of high inflation (Latin American, Russia, Hungary, and Poland). Rate hikers also include some developed market central banks such as Norway, New Zealand, and potentially the Bank of England. These developed central banks don’t have credibility problems, but credibility success with inflation having been a target during the last economic cycle.


There are some central banks that are patient for now but are likely to shift policy next year. This includes central banks that have yet to see persistent inflationary pressures emerge (Canada and Australia). Here market pricing may be aggressive, as markets expect Canada to hike four times next year and Australia three times. The U.S. Fed would also fall into this group. U.S. inflation is more persistent but did fall short of the Fed’s 2% long-term target during the last economic cycle.


Last, there are central banks that are some ways from raising rates. This includes central banks that saw significant shortfalls in inflation versus targets during the last economic cycle and still see a lack of inflationary elements (the European Central Bank (ECB) and the Bank of Japan). Markets are pricing in one rate hike by the ECB next year, but it is likely that they will remain “on hold” until 2023 or beyond.



While monetary policy “normalization” is beginning, it should unfold gradually, with rates moving from zero-bound levels. This is unlikely to pose a threat to global reflation and should still support global equities.


Seasonal Tailwinds


In recent prior Insights, we wrote about the seasonal headwinds of U.S. equity market performance during August and September. Thankfully, we are now past those historically challenging months and can look forward to two of the better months on the calendar for equity market performance. As you may note in the charts below, over the last 30+ years, November and December have had the 2nd and 3rd highest average returns, respectively, and 1st and 2nd highest probability of positive returns.



Let’s hope for another solid close to the year!


Have a great Sunday!



Timothy W. Ellis, Jr., CPA/PFS, CFP®

Senior Investment Strategist, Wealth Strategist




Sources: JPMorgan, Charles Schwab, Bespoke Premium, Edward Jones, CME Group, PIMCO
Author: Senior Investment Strategist Wealth StrategistSince joining W&A in 2014, Tim has been responsible for managing relationships with clients and providing financial planning services covering the areas of retirement, income tax, estate and gift, risk management, and education. In addition to client responsibilities, Tim serves on the firm’s investment committee assisting in portfolio construction and allocation as well as the searching and vetting of portfolio strategies. He is also an occasional author of W&A’s Weekly Strategic Insight commentary. Tim received his Bachelors in Accountancy and Masters in Taxation from the University of Mississippi in 2008 and 2009, respectively. He completed the CPA exam in 2011 and is a licensed CPA in the state of Tennessee. He earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) certification in 2014 and Personal Financial Specialist (PFS) credential in 2015. After completing his Masters at Ole Miss, Tim started his career at Reynolds, Bone & Griesbeck PLC as a tax associate in 2009. While at RBG, Tim worked with a wide range of clients, performing tax compliance and planning services for individuals, estates, trusts, partnerships, and corporations. Tim is a member and/or serves on the following organizations: • The American Institute of Certified Public Accountants • The Tennessee Society of Certified Public Accountants (Council member and VP of Programs and board of directors for the Memphis Chapter) • The Financial Planning Association (President-elect and board of directors for the Greater Memphis Chapter) Tim is originally from Marks, Mississippi, but has lived in East Memphis since starting his career. He is married, and he and his wife, Mary Agnes, are the proud parents to a son, Wilkes, daughter, Edie, and Goldendoodle, Penny.


Timothy W. Ellis, Jr., CPA/PFS, CFP®

Senior Investment Strategist

Wealth Strategist

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