I admit this is a rather strange title for a post, but bear with me. Every once in a while I reflect back on the so-called "taper tantrum" event in the summer of 2013 when Fed Chair Ben Bernanke made an off-the-cuff remark that the FOMC was thinking of maybe slowing down the pace QE3 asset purchases (see here). The stock market had a temporary sell-off, which turned out to be no big deal. What I find more interesting is how long bond yields rose sharply and persistently. Even more interesting, real bond yields behaved in this manner--see the figure below.
OK, so maybe the initial sell-off of bonds could be interpreted as the market being surprised that QE3 (an open-ended program) might terminate earlier than expected. But I just can't believe that QE programs can have such persistent effects on real interest rates. If that's the case, then what explains the broad pattern on display above, including the decline in real yields over 2011-2013?
I attribute it largely to the recession of 2012-2013. Wait, what recession, you say? Well, let's take a look. Contrary to standard practice, I'm going to look at per capita consumption (of nondurables and services). Here is what the data looks like.
Consumption growth per capita was negative from 2012.1-2013.3. The taper tantrum occurred in 2013.3. As you can see by this measure, the economy weakened considerably over the period 2011-2013. Over the same time, real bond yields declined. This is most easily explained as the consequence of an increasingly bearish outlook manifesting itself as an increase in the demand for safety (bonds).
Consumption growth turned positive in 2013.4, and continued to climb well into 2015. So while the tantrum may have contributed to the spike up in yields, the reason they stayed higher is because of an increasingly bullish outlook for the economy.
Does this interpretation make sense? What events were leading to the bearish outlook beginning in 2011. Certainly the events in Europe had something to do with it. I also think that domestic factors had a role to play, in particular, fiscal policy. Consider the following diagram.
What would the consumption and GDP dynamic have looked like if government purchases (per capita) had instead remain constant?
OK, so maybe the initial sell-off of bonds could be interpreted as the market being surprised that QE3 (an open-ended program) might terminate earlier than expected. But I just can't believe that QE programs can have such persistent effects on real interest rates. If that's the case, then what explains the broad pattern on display above, including the decline in real yields over 2011-2013?
I attribute it largely to the recession of 2012-2013. Wait, what recession, you say? Well, let's take a look. Contrary to standard practice, I'm going to look at per capita consumption (of nondurables and services). Here is what the data looks like.
Consumption growth turned positive in 2013.4, and continued to climb well into 2015. So while the tantrum may have contributed to the spike up in yields, the reason they stayed higher is because of an increasingly bullish outlook for the economy.
Does this interpretation make sense? What events were leading to the bearish outlook beginning in 2011. Certainly the events in Europe had something to do with it. I also think that domestic factors had a role to play, in particular, fiscal policy. Consider the following diagram.
David. Nice post. Now, check what went on with Mon Pol (NGDP growth YoY) in 2012-13!
ReplyDeleteNo wonder C weakned. Why no "recession" in 2010 or 11? Gov Puch falling fast. Ha! NGDP growth remained "robust"
There was also stuff going on on the tax side during this period. The Obamacare tax, the expiration of the Bush tax cuts (largely reinstated for all but high income individuals) and the expiration of the social security tax cut. You also had the spending cuts come in about then, and the effect on the deficit, if I remember was quite dramatic. Many predicted a recession.
ReplyDeleteThere was also stuff going on on the tax side during this period. The Obamacare tax, the expiration of the Bush tax cuts (largely reinstated for all but high income individuals) and the expiration of the social security tax cut. You also had the spending cuts come in about then, and the effect on the deficit, if I remember was quite dramatic. Many predicted a recession.
ReplyDeleteThe taper tantrum was due to a large but relatively slow change in market expectations regarding future interest rate increases by the Fed. This can clearly be seen in the Federal funds futures market during that time period.
ReplyDeleteRecall that before the taper announcement the markets were expecting the Fed would keep rates at zero pretty much as far as eye could see. There was talk of QE4ever. It was not the tapering of asset purchases per se that set off the tantrum. Rather the end of QE signaled that the federal funds rate would rise sooner than had previously been expected by markets.
There's no reason to appeal to any economic fundamentals to explain what was going on during that time. The Fed had basically decided it was time to start considering "normalizing" interest rates and the markets responded by pricing in more and sooner increases in the federal funds rate although that realization took some months to be fully priced into the federal funds futures and the 10 year Treasury bond yield.