The real question for the market will be the speed at which Fed tapering unfolds: Economist

Steven Ricchiuto, U.S. Chief Economist, Mizuho Securities USA, joins Yahoo Finance to discuss the market action following the FOMC meeting, outlook on the Fed tapering, and moves in the bond market.

Video Transcript

ALEXIS CHRISTOFOROUS: If you are just joining us here on our Fed special, the Fed tees up. The taper could happen as early as November also signaling that we could see our first rate hike by the end of next year. Want to bring in Stephen Ricchiuto now, US chief economist at Mizuho Securities USA. So Stephen, what is it about what the Fed said today that has the markets so happy?

STEPHEN RICCHIUTO: Well, I think what happened is they really haven't done anything that was terribly unexpected. And that's really what the market is comfortable about. Because everyone knew there was a potential for the Fed to downgrade the 2021 growth numbers, and the consensus had upgraded-- done the same thing, it downgraded 2021 and upgraded 2022.

People were expecting that maybe they'd move one dot into 2022, which they've kind of done. And people were expecting additional dots out in 2024. So really, nothing new came about. And the market tends to like when they kind of get things right. And this time the market kind of got it right going into the post-meeting policy statement and the SEP and the dots.

The real question for the market is going to be not whether they begin to taper in November or not, or announce the tapering in November or not, it's the details, the speed at which that tapering unfolds. And I believe it will be very, very slow and very, very steady. There are a lot of people on the committee, or some of the hawks on the committee who think it needs to be very, very fast and be done with very, very quickly. And that's going to be the real thing that the markets are going to begin to focus in on as we get heading closer and closer to that November meeting.

ADAM SHAPIRO: So if they do start, if they announce in November the pace at which they will stop purchasing mortgage-backed securities and treasuries, how does the market react if it's a slow pace? What does slow look like? Are we talking-- well, what would it look like?

STEPHEN RICCHIUTO: Well, slow and steady is $10 billion in treasuries, $5 billion in mortgages. Do that on a quarterly basis, get this over and done with by the end of 2023. You have to remember, there are people on the committee who'd like to see it done within a three to six month period of time, which would need a much more rapid deceleration, or cutback in the pace of purchasing. That, I think would tend to be a bit more of a curve shock than doing it slow and steady, because the market likes to know the predictability.

The market likes the concept that we know coupon issuance is going to be reduced, and we know that over time, because the Treasury is going to be borrowing more money, assuming they get past the debt limit, at current issue sizes, than they will currently need for fiscal year 2022. So we wind up in an environment where the curve can stay very, very flat and long term rates don't have to move very aggressively. So that's kind of what I think would be the most riskless scenario for the Fed rather than the very, very quick taper which I think would lead to a knee-jerk response higher and then it would wind up correcting itself.

ALEXIS CHRISTOFOROUS: You know, Stephen, we know the Fed has been backstopping the credit markets for quite some time now. Yet, there are many market watchers who believe there's more risk in the high-yield market versus the equity market at the moment. Would you agree with that? And why do you think that is?

STEPHEN RICCHIUTO: Well, I don't agree with that. I mean, balance sheets are very, very healthy. When you look at the non-financial corporate space, for example, yes, there was some increase in leverage, but they borrowed long. And the debt service burden for the non-financial corporate sectors back down to about mid-1975 levels. In addition to that, the consumer, which is important-- very, very important to the overall health of the economy-- has been de-leveraging for now 15 years, and leveraging long in a low-interest rate environment, and their debt servicing costs are back to 1979 levels.

So balance sheets are healthy. I don't think there's more risk in the high-yield market than there is in equities. Equities have a tendency of getting ahead of themselves. And what's happening in the bond market is strong foreign demand based on global deflation risks. And this is something that hasn't been talked about in any of the previous commentary, and it hasn't been talked about in many, many other commentary.

But you look at what the yield curve is telling you, the yield curve is telling you that this inflation is very, very transitory. And then we go quickly back to a deflationary concern again, and that's just is the reason why we're positive yield. We have such strong demand for our risk-based assets, because they do have positive yields attached to them.

ADAM SHAPIRO: Help us understand if we're just average folk investors what you just said. If we're going back to a normal kind of deflationary situation, and if I've got cash sitting to the side, it sounds as if even with the tapering, my only option is still equities.

STEPHEN RICCHIUTO: Well that's 100% correct, which is why you continue to stay in the risk asset marketplace, which is why you continue to look for a positive equity market development over time. Also keep in mind, we're in the early stages of an expansion, which is likely to be as long as the previous expansion, which was the longest in post-war period history.

So you can very, very well have a long, long expansion that unfolds. And also keep in mind, we're at the stage in the expansion where cash flows become more predictable, delinquency rates tend to decline, all of which are good for credit and longer-term, good for the equity market as well. The question is, whether to get ahead of themselves or not. Sorry.

ALEXIS CHRISTOFOROUS: No, absolutely. Thanks a lot. Stephen Ricchiuto, US chief economist at Mizuho Securities USA. Thanks for being with us.