The timing of balance sheet reduction is important because any reduction in the balance sheet reduces liquidity, which bodes ill for risk assets. At the same time, this would be a strong boost to the US dollar, as it will effectively reduce the supply of dollars. Given the current dynamics of the dollar selling off as risk rallies, understanding the taper’s timing is extremely important. We show the effects of a taper using our “All-Asset Return” framework:

In our view, a taper would effectively drag up expected returns in the United States, making dollars more attractive to hold relative to global risk assets. Hence, we need to understand what will trigger the Fed to consider tapering. In our view, it will be a combination of the following conditions:

Inflation >2% + Unemployment =4% + Vaccinations >75%

Looking at vaccination rates, inflation, and unemployment, we expect that all three will be conducive to a taper at the earliest around December 2021. There is a chance for this to get preponed, especially given that our outlook is dynamic. However, for now, we think that the December 2021 date offers a balanced target date. When taper becomes a more extensive conversation in markets, we expect a risk-off environment with a stronger dollar. However, there is a lot of time from now until December, during which time we expect risk-on to continue. However, the eventual pricing of a Fed taper would mean a dollar big against almost all major currency pairs.