Federal Reserve to adopt “tapering light” with $10bn to $15bn monthly reduction predicts Blackrock

17th September 2013

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The Federal Reserve is expected to begin tapering this week but it will do so gradually in a strategy dubbed “tapering” light by global fund management firm Blackrock.

Blackrock’s global strategist Russ Koesterich says: “Our view is that given the softness in the economic data and the lack of inflationary pressures outside of oil prices, the Fed will announce only a modest reduction in the rate of their asset purchase program.

“Specifically, we expect the Fed will reduce the size of their monthly asset purchases from its current level of $85 billion to somewhere between $70 and $75 billion. Additionally, since this sort of reduction appears to already be priced into the markets, we think that long-term interest rates should be relatively contained over the coming months.”

Koesterich says the Fed will not cut back more partly because it doesn’t have too because inflation pressures are almost nonexistent.

The note says: “Last week’s release of August’s producer price inflation data helped confirm this benign environment. Producer prices were up only a modest 1.4% on a year-over-year basis, and without the more volatile food and energy components, prices rose only 1.1%, the lowest level since the summer of 2010.”

The firm notes that the economic recovery remains shaky. “Job growth has not accelerated and wages and consumption remain soft. The housing market has grown as a source of concern, given the tight relationship between interest rates and housing. With interest rates rising over the past few months, mortgage rates have been climbing. This situation has already had a negative impact on housing activity and has severely curtailed refinancing. The Fed will be wary about taking any action that could put the housing recovery in jeopardy and does not want to see a steep backup in yields”.

Koesterich says that it is high yield bonds and emerging markets equities that should benefit though the recent volatility will remain.

The note continunes: “There will be a great deal of focus around the question of when the Fed intends to actually increase short-term rates, which we continue to believe won’t happen for some time. However expectations for a taper lite appear to be reflected in the markets, meaning that absent stronger economic data, interest rates are likely to remain range-bound for the coming months”.

Blackrock says that in the near term, high yield bonds should benefit from an environment of stable rates and a slowly improving economy. Another asset class to consider is emerging markets equities. “This area has been punished in recent quarters as higher interest rates and a stronger US dollar have been putting pressure on many emerging markets currencies. A more stable interest rate environment should translate into better performance for emerging markets equities, a trend that we have already started to see in recent weeks”.

 

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