Markets’ Nervousness Over Tapering Ebbs

Some investors are betting stock and bond prices will continue their smooth sailing even as the Federal Reserve prepares to potentially trim its monetary stimulus.

Investors widely expect the Fed to say Wednesday it will reduce its $85-billion-a-month bond-buying program by about $10 billion to $15 billion a month. Markets were roiled in May when Fed chief Ben Bernanke said the U.S. central bank would consider reducing, or tapering, its purchases this year. The Fed’s policy-setting Federal Open Market Committee is due to announce its decision at 2 p.m. Eastern time Wednesday.

What will the Fed do at its meeting this week? WSJ’s Jon Hilsenrath says it’s a close call: markets expect the Fed to pull back slightly on quantitative easing. But continued worries about the economy may lead the Fed to hold off.

Some investors doubt there will be a panic this time around, because players in stock, bond and commodity markets have had time to adjust, and because market trends lately have been upbeat amid mixed economic news. The Dow Jones Industrial Average has advanced 4.6% this month to within reach of an all-time record, while the yield on the benchmark 10-year Treasury note has held steady around 2.85%.

“They’ve been talking about tapering going back several months now,” said Alex Roever, head of U.S. interest-rate strategy for J.P. Morgan Securities. “So we sort of think the whole idea of tapering is priced into the market.”

Some investors are focusing on the Fed’s signals about what it does next. Many stock investors say there would likely be few ripples from a decision by the Fed to make a one-off reduction in its bond purchases. In that scenario, future decisions by the Fed to scale back bond buying would remain “data dependent”—in other words, based on the pace of the economic recovery.


However, some investors say stocks could be in for a selloff should the Fed signal it has decided to set a steady course toward winding down its purchases.

Before the taper talk began in earnest, 10-year U.S. Treasury notes in May were yielding about 1.6%. Since then, the prospect of a major buyer pulling back from the market has driven down prices, pushing up yields.

But in recent weeks, the prices of mortgage-backed bonds from government-sponsored entities such as Fannie Mae and Freddie Mac—which the Fed has also been buying—have outpaced Treasurys. Some analysts reason that reductions to the Fed bond-purchase program won’t lead to lower mortgage-bond prices, because the supply of debt in that market is also falling.

Treasurys themselves have risen in recent days as many investors decided they had been oversold and as short sellers bought bonds to close out their bets.

“The largest moves in rates don’t come when the Fed is acting, they come when expectations change about the Fed acting,” said Gene Tannuzzo, a portfolio manager at Columbia Management who helps oversee the $3.5 billion Columbia Strategic Income Fund. “That’s what we saw in May, June and July.”


He said that three months ago, the fund’s duration—a measure of its sensitivity to interest rates—was low compared with its benchmark. Now, he said, it is about the same.

To be sure, if the Fed decides to reduce its monthly purchases by more than $10 billion to $15 billion, markets could sell off, investors said. And investors said a quick, knee-jerk reaction is possible once headlines hit about any slowdown in Fed purchases, even if the amount is in line with expectations.

What is more, the Fed has ended similar stimulus measures before, most recently in March 2010 and June 2011. During those periods, yields on the 10-year Treasury note crept up slightly and stock prices tumbled by double-digit percentages.

Also possibly moving markets: The FOMC on Wednesday is expected to release its 2016 economic forecasts for the first time.

Brian Pollak, portfolio manager at Evercore Wealth Mangement, which oversees $4.7 billion, said he believed that a Fed tapering was largely priced into the market. But he said the firm was still girding against interest-rate changes by moving into more floating-rate leveraged loans, certain mortgage- backed securities and some high-yield securities, expecting rates to go higher eventually as the economy improves.

“While we think we’re in this rising rate cycle, we don’t know the timing of it,” Mr. Pollak said.

In foreign-exchange markets, investors have recently been selling the dollar, concerned that a recent spate of weak U.S. economic data may lead the Fed to announce a smaller-than-expected reduction of its bond buying. Others say the Fed’s tapering plans are already factored into the dollar’s value, meaning there’s little reason for it to rally further.

“In general, a lot of people are of the view that tapering’s been priced in,” said Akshay Krishnan, a senior analyst at Stenham Asset Management who helps clients invest in hedge funds.

In commodities markets, many investors said the tepid global economic picture was likely to reduce players’ interest in the details of the Fed move.

“Most traders are disregarding the Fed as an agent in the commodity markets and are instead looking at supply and demand fundamentals to inform their positions,” said Dan Norcini, an independent livestock trader based in Idaho. “Funds are not going to chase commodities higher while the employment picture remains dismal.”

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