Last year’s spectacular “taper tantrum” in markets is something of a misnomer. It was an episode of “risk off” behavior driven in part by the Federal Reserve move to begin tapering quantitative easing (QE). US bond yields suddenly soared as higher interest rates became an expectation. That saw capital repatriated from emerging markets economies to the US and, as the MSCI emerging markets (EM) index shows, equity was hit hard (so was debt and forex):
But there was another very important factor in the tantrum that is usually forgotten. The timing coincided with a sharp slowing in the Chinese economy after its 2012 round of stimulus (which wasn’t that “mini”) and that set up a feedback loop for markets to rush out of EMs because they are very China export dependent. Couple that with the withdrawal of capital chasing higher interest rates in developed economies and you had a near perfect storm in EM external balances.
Markets have since recovered handsomely owing to two changes. The Fed managed to convince markets that tapering was not tightening and the backup in bond yields stopped (and has been reversing ever since). Secondly, China launched another mini-stimulus and turned its economy back to growth quick smart. You can see this in the PMI chart:
The stimulus kicked the can for about 8 months and then another kick was required three months ago. Now that kick is also waning, much faster than even I expected, strongly suggesting that each kick is less effective than the last.
More importantly, China is going to slow further under pressure from housing. We’ll no doubt see more targeted stimulus but it’s a losing battle while housing falls. There is no “recovery underway” nor coming. This is a structural adjustment to slower growth that is being managed down using bouts of fiscal spending.
So, back to the purpose of this post – taper tantrum 2.0 – I have one more factoid to add. Last night we saw relatively hawkish minutes from the Fed. Moreover, we’re headed into the Jackson Hole pow wow, where everyone is expecting dovishness galore. Well…they better get it.
I’ve not been concerned for markets by the geopolitical unrest of recent times even though it hit German growth. But this sudden slowing in China is different. It is being driven by a housing bust (however large) that was also exposed by terrible July credit figures (from which we’ll see some kind of rebound no doubt). It has the potential to weigh heavily on the EM complex and if markets suddenly get spooked by Fed hawkishness as well then markets are confronting a developing segue of the same forces that triggered the taper tantrum in 2013.
US bond rates are not backing up at all and that will prevent a recurrence of a rout of the same magnitude one would think but there’s still plenty to trigger a pretty decent equity and forex correction, focused again on emerging markets.
A kind of smaller echo tantrum does not seem at all impossible.