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A reduction in Federal Reserve monetary stimulus has been the most likely scenario for three months and all but the most negligent of fixed-income portfolio managers have realigned their holdings in preparation. But no matter whether the official tapering announcement comes Wednesday or at a future meeting, if the pace of withdrawal defies the bond market's expectations, a bond market rally is at least as likely as a significant selloff.
There is no shortage of pundits predicting post-taper doom. The usually insightful Sheila Bair, former chairwoman of the Federal Deposit Insurance Corporation, warned in a recent Financial Times editorial that "the storm season will soon be upon us."
The assumption underlying these apocalyptic predictions is that large institutional fund managers – those who drive bond markets with large buy and sell orders – have been sitting on their hands since May, anxiously twiddling their thumbs and awaiting Mr. Bernanke's press conference.
Yet even though the economic backdrop has barely changed, the 10-year U.S. Treasury bond yield is already 124 basis points higher since the chairman suggested reducing monetary stimulus. In other words, big investors have already been discounting tapering. There might be some minor adjustments based on the speed at which stimulus will be withdrawn, but the majority of the move has been priced in.
As always, it pays to ignore the pontification on business television – where accountability is vague – and look to where the most prominent global investors have made bets with their considerably fat wallets. In this case, it's Eurodollars.
The Eurodollar futures market is where the world's largest lenders attempt to predict future interest rates (more on how it works here ). The risks of being wrong are considerable – Eurodollar contracts are $1-million (U.S.) each and represent actual commitments to either borrow or lend funds at a particular interest rate.
Eurodollars predict interbank lending rates will 50 basis points in September of 2014, 25 basis points higher than now. This would be a significant move, but it pales in comparison to the bond market upheaval in the last four months.
The interest rate environment in 2014 and beyond will be determined by U.S. economic data, among many other factors. But unless something unforeseen happens, it's a mistake to expect a huge spike in yields before the end of 2013.
For the big money, tapering has been the most likely scenario for three months and they've already done all they can to prepare their portfolios. The official announcement is merely a formality.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .
Scott Barlow