At the November FOMC meeting, the Fed officially announced that it would begin tapering its bond purchase program, starting in mid-November. At a pace of reduction of $10 billion each month, the Fed’s latest program, which began 21 months ago in March 2020 and has added nearly $3 trillion worth of Treasury securities to date, will terminate in mid-June 2022 should the pace hold.
Now faced with another tapering, many market participants recall the infamous “taper-tantrum” episode in 2013 when the unexpected Fed contemplation of tapering caught the market off guard and caused financial turbulence. That said, there are differences between that episode and this one. First, the market largely expected this announcement, and second, the net supply picture will actually be improving next year even in the absence of Fed buying.
When the Fed began tapering its QE3 program over the course of 2014, the coupon supply from the U.S. Treasury was stable, leading to an increase in net supply takedown from the private market; however, the Treasury is currently overfunded in the current coupon program and thus is likely to make substantial cuts over 2022. In short, the cuts will far outstrip the impact of Fed tapering on par coupon supply; we project that gross issuance net of Fed purchases in nominal-coupon Treasuries and TIPS will drop $150 billion in 2022 compared to 2021. Further, this net supply impulse is likely to weaken over the course of the year as the Treasury continues to reduce its coupon program.
Not only is this a different supply dynamic from the one that persisted in 2014, but it also reveals an interesting feature of this latest QE program: The market has already digested the bulk of the net supply increase prior to the Fed’s tapering. Because the Fed initially purchased Treasuries at such a fast clip at the onset of the pandemic, the reduction from this elevated activity to its current pace of $80 billion per month, at the same time as the Treasury was increasing its coupon program through the end of 2020, means that investors have already taken down the largest increase in par issuance through the first half of 2021. Ultimately, Fed tapering may impact markets, but investors have proven capable of handling this type of supply.