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September 2021 | GSAM Connect

How worried should we be about Taper Tantrum 2.0?

Three reasons why we don’t expect rising 10-year Treasury yields to cause another sell-off in emerging markets debt.

Concerns about China slowing, the spreading of the delta variant and uncertainty over the outlook for monetary policy in the US have put downward pressure on US long-term bond yields in recent months. However, with the US economy continuing to recover and the US Federal Reserve (Fed) expected to start discussing tapering of asset purchases soon, concerns over a sudden and material rise in US yields, and what that would mean for emerging markets, have understandably re-emerged.

Back in 2013 when the then-Fed Chair Ben Bernanke suggested that asset purchases could be reduced, US 10-year real and nominal yields surged, triggering a sell-off in emerging markets debt. Credit spreads on emerging markets debt, which had tightened sharply in the preceding three-to-four years as the Fed’s easy money regime sent investors hunting for yield in emerging markets, widened. And pressure in foreign exchange markets forced central banks in several emerging markets to raise interest rates in order to protect their capital accounts.

While we expect the yield of 10-year Treasuries to rise over the coming months, there are three reasons why we don’t think that this will cause another big sell-off in emerging markets debt.

First, we don’t think that yields will rise as far or as quickly as in 2013.

Our forecast is for the 10-year Treasury yield to end 2021 at around 1.60%, which is roughly a~ 30 basis point (bp) rise from its current level. Back in 2013, the nominal yield rose by about 140bp between May and September, as the Fed failed to reassure markets that tapering would not be immediately followed by policy tightening.

In our view, the Fed has learnt from past mistakes. The Federal Open Market Committee has gone to great lengths to stress that tapering will precede any consideration of rate hikes. While inflation is much higher now than in 2013, the Fed’s recently-adopted Flexible Average Inflation Regime (FAIT) means that it is likely to act with more caution when it comes to tightening.

Our expectation is for the Fed to provide more guidance around its balance sheet in the upcoming September meeting, with tapering likely to start in November and the first policy hike in mid-2023.

It is also worth keeping in mind that the size of the balance sheet is more important than the pace of the purchases in influencing long-term yields. At ~US$8.2tn, the Fed’s balance sheet is almost three times as big as in 2013.

Second, higher yields are justified by strong US and global economic growth.

The reason why yields are rising is just as important as the extent of the rise. In 2013, rising yields were the result of the Fed’s decision to taper its asset purchases, rather than above-trend growth: at a GDP growth rate of 1.8%, the US economy was hardly overheated!

By contrast, higher yields today are justified by improved economic prospects. Recall that the global economy is set to expand by 6.3%* in 2021 — its strongest post-recession pace in 80 years. And at 6%*, US growth will be the fastest in 40 years.

Solid global and US economic growth ought to be positive for risk assets such as equities, emerging markets debt and commodities.

Third, emerging markets are less vulnerable to a rise in US yields.

Back in 2013, the “fragile five”— South Africa, Brazil, India, Indonesia, and Turkey — had substantial current account deficits, and were therefore heavily dependent on inflows of foreign capital.

The pandemic has improved the current accounts of many emerging markets (see exhibit below.) Sharp recessions have caused imports to collapse and current accounts to move into surplus. Structural current account deficits will probably re-emerge as economies recover, but as things stand most emerging markets are better positioned to withstand a capital flight. Moreover, the flow of external resources into emerging markets in recent years has been nowhere close to as large as in the years before the 2013 taper tantrum. Nor are real exchange rates as overvalued as they were at the time.

Exhibit: THE CURRENT ACCOUNTS OF THE “FRAGILE FIVE” HAVE IMPROVED

Source: Goldman Sachs Investment Research and Goldman Sachs Asset Management. As of August 2021.

Overall, we think the macroeconomic backdrop remains supportive of further gains in risk assets. As the global economy continues to grow at a strong pace aided by further progress in vaccinations, and investors hunt for yield in an increasingly difficult market, we expect some further spread compression in emerging markets debt. Though another sudden surge in US yields could spark a period of global risk aversion, with emerging markets assets coming under pressure, improved macroeconomic fundamentals suggest that emerging markets would bounce back more quickly this time.

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ABOUT THE AUTHOR

Simona Gambarini,

Simona Gambarini,

Senior Market Strategist, Strategic Advisory Solutions, Goldman Sachs Asset Management

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