Taper tantrums could end in tears for bondholders

In these days of hyperactive communications from central banks, it is hard to remember just how secretive policy makers used to be. It was only in 1994 under Alan Greenspan that the Federal Reserve first announced what it was doing with the main Fed Funds rate. Back then, the tightening of policy prompted a bond sell-off not matched until the taper tantrum of 2013.

The International Monetary Fund fears that the Fed's much-discussed lift-off from zero rates could lead to a "super taper tantrum", even worse for emerging markets (and bondholders). Unless it doesn't. The alternative to a bond market rout is that long bonds ignore tightening central bank policy, as they did for much of the 2004-07 rate cycle, due to a global savings glut.

Worrying about either outcome may be moot, as the slowing US economy pushes back the prospect of the first rate rise. Futures markets suggest a 50-50 chance of a rise by the end of this year, the lowest in a long time - although a reminder from Stanley Fischer, Fed deputy chair, that a hike is on the way pushed up bond yields on Thursday.

The 2013 tantrum was a mistake by markets, which assumed talk of tapering the Fed's bond purchases marked the start of a cycle of rate rises. The Fed took months to calm the markets with clearer communications.

This time it is hard to believe there is anyone who would be surprised by a rise, even if it happens a little earlier than investors currently expect. But the same applied in 1994: tighter policy had been widely trailed, yet the bond market was still taken aback.

What should matter for bond yields is how fast rates are likely to rise after the first tightening. The Fed has spent a long time trying to explain that it will depend on the economy. Policy makers' own forecasts remain far above those of markets, though. The danger is that the first rise prompts a re-evaluation of the path of future rates and a snap higher in yields to match Fed predictions.

For now, weak data are helping keep yields depressed, with more disappointing US housing figures on Thursday. But if the economy strengthens, as most expect, the tension between the savings glut and a new bond market tantrum will risk serious volatility.

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