What if the central banks of Europe, Japan and the US all take their foot off the monetary accelerator at the same time? It seems nearly impossible, yet, that's exactly what Morgan Stanley's global economic team suggests could happen next year.
There's been much speculation about when the Federal Reserve will back off its monetary accommodation and raise interest rates. But few investors have considered another potential and possibly more painful scenario: that the Fed, the European Central Bank and the Bank of Japan all reduce monetary accommodation at the same time.
From where many investors stand today, that seems nearly impossible. Yet, that's exactly what Morgan Stanley's global economic team suggests could happen next year in its recent report, “A Triple Taper Tantrum?" (May 6, 2015). That tantrum refers to the potential reaction of investors and global markets—accustomed to years of easy money—in the face of a simultaneous rise in interest rates and yields in the US, Europe and Japan.
While the macro signs are there, a triple taper could still surprise investors. “None of these are yet on investor screens in a manner that affects their investment decisions, if our conversations are anything to go by," says Manoj Pradhan, global economist at Morgan Stanley. And if a 2013 taper tantrum in the US offers any lesson, this triple taper could very well be greeted by an even more emphatic market and investor tantrum. Though the pain will likely be short-lived, investors would be wise to prepare.
Data Dependent Decision
As it considers when to tighten monetary policy, the Fed is looking beyond what's happening in the US. “The Fed is internationally data-dependent," says Pradhan. “Data in the euro area, and even Japan, matter as much as economic strength in the US economy if the Fed is to be successful in removing monetary accommodation for next year or two."
That's because, in this global economy, what one central bank does other countries feel, and vice versa. If Japan and Europe aren't prepared for rising interest rates out of the US, the Fed's action could impede their fight against deflationary tendencies and economic growth. The US then stands to import that weakness through a stronger dollar. Mindful of this potential ripple effect, the Fed wants reassurance that the still-recovering European and Japanese economies can withstand even minimal policy tightening.
Recent data suggest they may be on their way.
In the euro area, consumer prices (or inflation) ticked up by 0.1 percentage point to 0% this past spring. Morgan Stanley economists anticipate a more marked increase by the end of 2015 and into next year. That will likely encourage the ECB to begin tapering its bond-buying stimulus program by the end of 2016.
Japan is also showing signs of stabilization, with the economy growing by 3.9% in the first quarter. Additionally, “wages are already accelerating at a pace that would end deflation in 2016," according to Robert Feldman, Morgan Stanley's Japan economist, adding, “Once deflation ends, the Bank of Japan cannot continue the quantitative easing that currently monetizes the deficits."
Growth and Policy Convergence
No doubt, even the specter of policy tightening can agitate investors and financial markets. The original taper tantrum occurred in spring of 2013, after then Fed-chair Ben Bernanke hinted that the Fed would begin backing off its bond-buying stimulus program. The news immediately sank markets; bond yields spiked. In fact, the interest rate on the 10-year Treasury rose a full percentage point between the announcement in May and the following September.
If the US, Japan and Europe continue to see improved growth and healthy inflation, we may witness a triple tapering in 2016. What would that entail? The Fed would likely reduce its reinvestment of its mortgage-backed securities in the first half of next year, following an interest rate increase, while the BOJ and ECB both reduce asset purchases around the middle of 2016.
A few developments could derail such a scenario. Despite recent progress, Japan's economic recovery could falter (as it has so often in the past), and Greece's fiscal woes remain a threat to the eurozone. In the US, slower-than-expected first-quarter growth and stalled consumer spending may prompt Fed policymakers to delay raising rates.
Still, for savvy investors, paying close attention to the eurozone and Japan, as well as the US, could help them prepare for a triple taper—and the ensuing tantrum.
For more Morgan Stanley Research on global economic trends, ask your Morgan Stanley representative or a Financial Advisor for the full report, “A Triple Taper Tantrum?" (May 6, 2015), and more continuing coverage.