Morning Notes — Tapering Implications

Tapering: The new focus on Fed tapering has mixed implications for markets.  The near-term implications are net positive as the conversation reduces investor concerns for a Fed policy mistake.  Prior to last week’s release of FOMC minutes, markets had no official indication the Fed was contemplating a timeline for dialing back asset purchases (QE). In light of the recent spike in core CPI, just the acknowledgement of an eventual plan was enough to dilute worst-case inflation fears. We saw this play out in bond markets over the past week as 10-year yields declined 14bps from 1.69% to 1.55%. The intermediate-term implications are probably neutral, but an eventual Fed tapering is only a headwind for bond prices (tailwind for higher yields) as it reduces a major source of demand.  A 2013-like taper-tantrum event for equities probably isn’t in the cards given changes to the frequency of Fed messaging and concerns that outgoing Fed chair Bernanke’s 2014 replacement would be more hawkish.

Banks: In addition to setting monetary policy, the Fed also acts as the primary regulator for US banks.  The Fed recently added a new stress test called the Stress Capital Buffer (SCB). If a bank passes the SCB, it no longer needs Fed approval (unlike the past decade) on capital return programs like stock buybacks and dividends.  Banks have accumulated massive amount of capital since the pandemic and large cap banks (money centers, trust banks and super-regionals) will significantly increase their stock buybacks in H2’21 and will remain high through 2022.  Bank capital return programs (buybacks and dividends) over the next ~18 months could exceed EPS by 100%.