TAPERING - SECOND ROUND

But the path With just six weeks of 2013 left, the question of when the Federal Reserve will begin to drain stimulus from the US economy remains the dominant one in financial markets. And with good reason.

It’s hard to find a financial market that wasn’t jolted in the early summer, when departing Fed chairman Ben Bernanke first signalled that five years of easy money was coming to an end.

US Treasury yields soared more than a percentage point; riskier assets, including emerging market bonds, equities and currencies were clobbered and the dollar jumped.

While the conversation about when the Fed will begin to slow – or taper – its stimulus programme still dominates, some are sceptical that financial markets will deliver a repeat of their summer swoon when the central bank does eventually reduce its bond-buying programme.

Economists at JPMorgan, for example, point out that emerging market assets – a beneficiary of the Fed’s bond-buying programme – have now priced in the likelihood that the central bank will tighten the stimulus tap.

As a proxy, they point to the spread (or difference in yield) between dollar-denominated junk bonds sold by emerging market companies and those issued by US companies. As the chart below shows, the spread has remained close to levels reach in May, when an added layer of risk was attached to emerging market assets.

They also argue that, much more forcefully than was managed over the summer, officials at the Fed will insist that tapering the bond-buying programme is quite different from any move to raise the central bank’s key interest rate.

Many economists now expect the Fed to underline this point by lowering the unemployment threshold – currently at 6.5 per cent – at which it has said it will consider raising its key interest rate.

Such arguments do offer some comfort that the Fed’s second attempt at tapering, currently forecast for the first quarter of 2014, will have a more muted effect on financial markets.

that Janet Yellen, the incoming Fed chairman, will have to tread when the Fed chooses to taper remains a testing one.