‘Taper tantrum’ and inflation replace Covid as top investor worry


Coronavirus has been overtaken for the first time since the early days of the pandemic more than a year ago as the top risk that keeps investors up at night, according to a new poll of fund managers.

Money managers polled by Bank of America now see inflation and an unruly rise in borrowing costs like that seen during the 2013 “taper tantrum” as the key “tail risk” that could unsettle global markets.

The survey of investors with $597bn in assets under management highlights investors’ concern that the economic recovery from Covid-19, backed by unprecedented stimulus, may unleash a surge of price growth that could be difficult to tame.

Rising inflation expectations and bets that central banks, particularly the US Federal Reserve, may have to tighten policy sooner than planned have triggered a widespread sell-off in government bond markets — which investors worry could get worse. 

“It’s a catch-22 for the Fed,” said Jim Caron, portfolio manager at Morgan Stanley Investment Management. “They want to communicate that they are going to be patient but the more patient they are, the more people will worry about inflation.”

Investors in the BofA poll expect that inflation will rise, at least in the near term, with an all-time high of a net 93 per cent of managers in the survey anticipating more rapid price increases in the coming year. A majority now see higher economic growth going hand in hand with higher inflation. Previously, investors had been more optimistic about a “goldilocks scenario” of lower inflation paired with strong growth. 

Line chart of 10-year break-even rate (%) showing US investors brace themselves for higher inflation

“We believe 2020 likely marked a secular low point for inflation and interest rates,” Michael Hartnett, BofA chief investment strategist, said last week.

Expectations of rising inflation have sent shockwaves through the bond market this year, because inflation eats away at the interest payments on bonds. The US 10-year Treasury yield, one of the world’s most closely watched interest rates, has risen past 1.6 per cent, up from 0.9 per cent at the beginning of the year, as investors sold the debt. Meanwhile, the 10-year break-even rate, a key measure of inflation expectations, now sits near its highest level since 2014.

Traders have worried about a repeat of the taper tantrum of 2013 when the prospect of the Fed withdrawing stimulus following the global financial crisis prompted a severe sell-off in bonds. 

“Previous episodes have demonstrated that what starts as a benign correction could evolve into a tantrum with wider consequences. Our modelling of a severe market scenario finds a significant impact on growth,” said Innes McFee, chief global economist at Oxford Economics. 

A large share of fund managers in the BofA survey said a 2 per cent yield on 10-year Treasuries would prompt a correction of at least 10 per cent in equity markets. 

Investors reported the biggest cut in 15 years to their exposure to tech stocks, which have suffered during the bond market rout. Bets on tech were still deemed the “most crowded trade”, following by bitcoin and ESG.

The readout on investor fears comes on the first day of the Fed’s two-day monetary policy meeting. Central bankers have talked down the risk of inflation and reinforced that they have no plans to increase rates until the economic recovery from Covid-19 is well under way.

“The Fed’s challenge is to manage the transition from a low to a high interest rates regime without causing market mayhem,” ING analysts said ahead of Wednesday’s decision by the Federal Open Market Committee.

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