Weekly Market Commentary- Still Obsessing over the Taper

To taper or not to taper, that is the question. It’s beginning to feel like a Shakespearean tragedy, with yields vacillating on whether the odds favor a December, January or March taper. For our part, we will guess January and will not be surprised if something happens in the upcoming weeks. We will also proffer that it does not really matter in the grand scheme of things which one of those three dates are chosen by the FOMC, it is the fact that the process of normalization is starting, which is ultimately not a bad thing. The curve has steepened significantly, and remains at multi-year wides, as the Fed’s message that tapering is not tightening has been embraced by the market. From this perspective, the Fed has succeeded in its primary goal of convincing the market that a rate hike is not imminent once tapering begins. While we have heard less on the topic of tying rate hikes to a full employment rate, we have begun to hear about the Fed’s ability to manage short rates through change in the interest on excess reserves (IOER) and expanded use of its test reverse repo mechanism. We view many of these discussions as trial balloons released by the Fed to gauge the market’s acceptance of possible optimal control strategies. They also highlight to us that they are preparing the market for tapering, although attempts to control longer term yields remain challenging. This leads us to think that yields can continue to grind higher, even though we are multi-year wides across the curve as investors position for less fixed income exposure next year. Rising rates have not dampened demand for corporate bonds however, with 2013 new issue volumes likely to exceed last year’s record setting sales. Corporate and high yield spreads are also at post-crisis tights, which we think makes further gains challenging. Friday’s employment report will be the most important data point prior to the FOMC meeting taking place December 17 – 18. Consensus is for +180,000 jobs, although today’s stronger than expected ADP report will likely raise the whisper expectations above 200k.