A potential issue with such a change in policy was highlighted by the so-called “taper tantrum” of 2013. To recap, this was when US economist Ben Bernanke inadvertently sent yields surging and bond prices falling when he said that tapering would begin only if and when there was consistent evidence that US employment conditions were improving.
Mr Bernanke also specifically stated that, even after tapering started, the Fed would not allow US monetary conditions to tighten and would keep short-term interest rates near zero for a very long period – at least until 2015, and quite possibly beyond. Yet, despite this, markets were spooked by the potential change in direction.
Returning to the present day, on top of the recent announcements by the Fed, in a wider context the Bank of Canada raised interest rates for the first time in nearly seven years in July, while both the ECB and the Bank of Japan have hinted that their quantitative easing programmes could slow or even reverse, changing demand to supply.
The result of all this is that many investors fear heightened volatility, falling bond prices and even perhaps a bond market crash as central banks change course, but others take the view that people have been saying there is a bond bubble for years, but bonds have continued going up.
One of the main current arguments against a potential bond market crash is that global growth is still low, which means inflation is unlikely to become a problem for an extended period of time resulting in a slow, well communicated tightening from the US and others with any changes priced in by investors in advance.
There is no doubt that following Mr Bernanke's “taper tantrum”, central banks have to date been very careful in testing the waters by giving markets hints of their plans and taking tiny steps. However, as I have said, there is no guarantee this strategy will continue in the future, especially as the leadership at the Fed changes.
Where to invest in the bond market
The bond market is a many-headed beast with government bonds and company bonds, short-dated bonds and long-dated bonds, index-linked bonds and western and emerging market bonds, to name just a few. So where should you be investing?
It depends on your outlook for the bond market, bearing in mind the risks outlined. I talk to many fund managers and some are simply not investing in the bond market at all, preferring instead to hold cash or dip their toes in the absolute return space. Others are still confident in various pockets of the market, such as high-yield bonds, but are aware of the duration issue in terms of future potential increases in interest rates.