- Tapering could hit stocks but UBS says strong underlying earnings offer support to share prices
- European Central Bank has just announced a reduction in quantitative easing programme
The slow withdrawal of the massive central bank quantitative easing programmes has begun, with the European Central Bank announcing a "recalibration" of its Pandemic Emergency Purchase Programme this month, while expectations rise that the US Federal Reserve and Bank of England will soon start closing the cheque books as well.
Central banks globally have helped whip up this equities bull market, where the S&P 500 hit another all-time high at the end of August, leading to the conclusion that the slow withdrawal of these quantitative easing policies could pull the rug out from under equity-heavy portfolios.
Companies are trading strongly for other reasons, however, say market observers. Nick Nelson, head of European equity strategy at UBS, told Investors' Chronicle that August saw the "best earnings upgrades for companies in Europe since the data began". This is in the context of markets that "care about corporate profit growth" with UBS holding that earnings growth in Europe will be up 60 per cent for the year.
While there may be a "short-term" impact on equity markets depending on the rapidity and depth of tapering policy, Nelson holds that equity yields will remain attractive to investors given bond yields have remained low. The UBS house view is for 10-year Treasury yields to be sitting at 1.8 per cent by the end of the year, compared with the current level of around 1.3 per cent.
All eyes will be on the two-day Federal Reserve meeting starting 21 September after officials indicated that the tapering of its $120bn-(£87bn)-per-month asset-purchase programme may begin this year. The president of the Federal Reserve Bank of Cleveland, Loretta Mester, told CNBC last week that "substantial further progress" made on inflation and employment meant that tapering could proceed.
Other officials made similar noises: the president of the Federal Reserve Bank of Philadelphia, Patrick Harker, argued that high levels of monetary stimulus "is no longer relevant" in an interview with Nikkei. The US dollar reached a two-week high on the back of the tapering statements.
Interest rates are closely linked to the tapering discussion, with quantitative easing – done through purchasing government debt and mortgage-backed securities – supporting the ultra-low rate environment.
Neil Wilson, Chief Market Analyst at Markets.com, said the "value, cyclical" parts of the market such as financial services will benefit. With the expectation of interest rate rises it is the "pricier" and "technology growth ends of the market" Wilson said would be hit most by tapering.
In Wilson’s hawkish view, the central banks have been unjustifiably slow in taking action on tapering in light of the return of "pre-pandemic economic conditions" and high inflation. The US August consumer index data confirms that inflation has been higher than 5 per cent for the third consecutive month – this shows that inflation is "stickier than the Federal Reserve is letting on", Wilson said.
Unlike the Federal Reserve, the European Central Bank has made a concrete tapering announcement. Bank president Christine Lagarde announced in Frankfurt a "recalibration" of the €1.85tn (£1.58tn) Pandemic Emergency Purchase Programme (PEPP) which will see monthly purchases fall from €80bn to €60bn-€70bn a month.
The Iron Lady of central banking echoed Margaret Thatcher in her speech, claiming that "the lady isn’t tapering". The bank’s longer-running €20bn per month Asset Purchase Programme (APP) continues. The most significant reaction was seen in the European bond markets, with the yield on Italian 10-year bonds falling by over 8 basis points.
In London, Bank of England governor Andrew Bailey has recently reaffirmed a meandering process to unwind the institution's £895bn quantitative easing programme. Speaking before the Treasury Committee earlier this month, Bailey stated that tapering would be done in a slow and methodical way once the Bank rate is increased to 0.5 per cent. This is not expected by the market until 2023.
UBS economist Anna Titareva said tapering was "built-in" to the Bank of England’s latest announcement of gilt purchases (£150bn in November 2020) due to the weekly rate of asset purchases at the time and the bank stating that purchases will be completed by the end of 2021 – the expectation of tapering has been factored in by the market. The Federal Reserve and the European Central Bank, by comparison, work with monthly purchase amounts and have to be more explicit about slowing stimulus.
Policy changes from the Old Lady of Threadneedle Street do not have the same impact on global bond yields as the Federal Reserve and to an extent the European Central Bank. Wilson said changes to Bank of England policy won’t have a "particularly meaningful" impact on the stock market.
Fears remain in some quarters that hawkish central bank moves on monetary policy could lead to another ‘taper tantrum’.
In 2013 US government bond yields shot up and share values plummeted on the news of Federal Reserve plans to tighten monetary policy. However, this time around the markets have had sufficient time to digest the idea of future tapering, so a pullback on spending should not bring on any drastic market movements.
