Economic commentary: What is tapering and how could it impact financial markets?

In debt markets, bond prices dipped, and yields rose as investors started to sell their bonds. As a result, the 10-year Treasury yield went up from 1.94% on May 21 to 3% by December 2013. QE can contribute to higher inflation than desired if the supply of money in the economy increases too much. On the other hand, reducing asset purchases decelerates the influx of liquidity into the market, which could theoretically bring about reduced inflation.

  1. Compared to the 2013 taper tantrum, the markets reacted relatively mutedly to the Fed’s tapering announcement in 2021.
  2. The bond market pushed 10-year Treasury yields up slightly, from 1.94 percent on May 21 to 2.03 percent on May 22, 2013.
  3. This has the effect of driving down US interest rates, including the cost of mortgages, car loans and financing for business.
  4. However, the Fed would only be expected to taper in response to strong economic conditions, and that means any downward pressure on stock prices would be met with an overall bullish economic environment.

While previous rounds of QE primarily involved the purchase of longer-term securities, during the pandemic, the Fed purchased Treasuries across a broader range of maturities. This was driven by the Fed’s original goal of calming a distressed Treasury market in March and April 2020. As a result, yields for these securities may rise, leading to loan interest rates increases.

Tale of Two Taperings: 2013 vs. 2021

However, the extent of that impact can vary depending on whether the markets are expecting the taper or if it comes as a surprise. That is the most recent phase of quantitative easing (QE), a policy that began as a response to the financial crisis that struck in 2007. In addition, the US dollar appreciated significantly as the monetary policy was tightened, and emerging market currencies depreciated against the US dollar. In stock markets, sell-offs happened in major stock indexes like the S&P 500 and Dow Jones.

Stocks Perform Better When Interest Rates Rise

Fed Chair Powell, a member of the Board of Governors of the Federal Reserve during the earlier taper, said in March 2021 that the central bank would “supply clear communication” well in advance of the actual tapering. Tapering does not involve selling the securities that the central bank purchased; it’s merely winding down the pace plus500 review at which those securities are bought. The Fed started tapering its purchases in December 2021 and by the spring of 2021, the economy showed significant strength and a cost-of-living surge. Since late 2012, the US central bank, the Federal Reserve (or simply the Fed), has been spending $85bn a month to boost the US economy.

Understanding Tapering

In response to the global financial crisis, the Fed began purchasing Treasury securities and mortgage-backed securities in 2009. The third, launched in September 2012, was open-ended; the Fed said it would keep buying bonds until labor market conditions improved. In December 2021, the Fed started cutting its asset purchases reducing its balance sheet. Over the next eight months, we saw a monthly reduction of $10 billion fewer Treasury purchases and $5 billion less mortgage-backed security purchases by the Fed. In December 2013, the Fed started to reduce its pace of asset purchases by $10 billion per month, terminating the last round of purchases in October 2014.

However, the prospect of US rate hikes and an absolute reduction in the size of the Fed’s balance sheet (i.e., the outright selling of bonds, or so-called Quantitative Tightening) are still some way off. In response to the economic impact of the COVID-19 pandemic, the Federal Reserve cut short-term interest rates to zero on March 15, 2020 and restarted its large-scale asset purchases (more commonly known as quantitative easing, or QE). From June 2020 to October 2021, the Fed bought $80 billion of Treasury securities and $40 billion umarkets review of agency mortgage-backed securities (MBS) each month. As the economy rebounded in late 2021, Fed officials began slowing—or tapering—the pace of its bond purchases. While the reduction in asset purchases will have a direct impact on the prices or yields of those assets, the bigger implication is what it signifies for the timing of the Federal Reserve hiking policy rates. These tapering announcements have typically resulted in sharp rises in government bond yields, yield curve distortions, and equity market sell-offs.

As a result, the Fed has implemented QE since the Global Financial Crisis in 2008, 2010, 2012, and 2020, respectively. The most recent QE in the US happened when the coronavirus 2019 (COVID-19) pandemic detrimentally impacted the American and global economy, triggering a recession in most countries in February 2020. “In fact, the S&P 500 has performed better in the wake of Fed decisions to raise the Fed funds rate than in the wake of rate cuts, on average,” he finds.

How Tapering Affects Financial Markets

In June 2022, the Federal Reserve changed its monetary policy direction to manage the threat of rising costs. The Fed revised its position after two years of an “easy money” policy, ending oanda review its policy of low-interest rates and significant intervention in the bond market. Under the plan, the Fed has been buying assets – a mixture of US government debt and mortgage bonds.

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