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For markets, Fed tapering is already here

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One of the most dovish members of the U.S. Federal Reserve's Open Market Committee hinted that the dreaded tapering of Fed monetary stimulus could be imminent. Thankfully, there are signs the much of the potential market damage is already reflected in asset prices.

Chicago Federal Reserve President Charles Evans said Tuesday that a reduction in the Fed's $85-billion (U.S.) monthly asset purchase program was "quite likely" before the end of 2013. As the originator of the Evans Rule – the Fed would maintain ultra-low interest rates until unemployment fell to 6.5 per cent – Mr. Evans has been among the most pro-stimulus members of the Fed.

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Chairman Bernanke has not raised interest rates, but his remarks in May suggesting that a reduction in asset purchases was on the horizon kicked off a major market sell-off that saw ten-year Treasury yields jump from 1.8 per cent to current levels around 2.6 per cent.

This 80 basis point increase in bond yields represents the market's preparation for declining Fed stimulus. In other words, the detrimental effects of tapering are, at least in part, already priced in.

Equities have also partially adjusted to the prospects of higher interest rates as analysts and investors attempt to quantify the effects of higher borrowing costs on future profits.

There are few indications of exactly when tapering will actually begin (although September is becoming the consensus view) or the pace at which direct central bank asset purchases will be reduced.

Market prices will react to the official decision relative to current expectations . If, for instance, the Fed declares that stimulus will be reduced at a slower pace than the market expects, the official announcement could actually result in a rally.

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.

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