Tapering: How, Why, and When the Fed Does It and Impact on Financial Markets

They hit low-end manufacturing—apparel, footwear, the usual suspects—but shrinking exports could accelerate industrial consolidation and boost efficiency. In the 1990s, it absorbed forty million layoffs during state-owned enterprise reforms. When it comes to employment, the Fed looks for several indicators of a healing labor market.

How will Fed tapering impact the stock market?

But such a future is very unlikely to happen, given the Fed’s careful implementation of tapering. It is important to recognize that securities purchases will not halt immediately – the Fed is still buying immense amounts of assets, albeit at a gradually lower rate. The U.S. central bank began tapering in November 2021, scaling back total purchases by $15 billion a month, from $120 billion to $105 billion.

As the economy rebounded in late 2021, Fed officials began slowing—or tapering—the pace of its bond purchases. To understand how tapering works requires a deeper understanding of quantitative easing. When central banks keep short-term interest rates low, it encourages individual borrowers and businesses to take out loans. At the same time, asset purchases by the central bank inject money into the economy. Bond purchases can impact market expectations about the future path of monetary policy.

It assists in moderating the speed of the growth in the economy and restricts inflationary pressure. Tapering is the first step in the process of either winding down or withdrawing from a monetary stimulus program that has already been executed and deemed successful. Communicating openly with investors regarding the direction of central bank policy and future activities helps to set market expectations and reduce market uncertainty. When central banks pursue an expansionary policy to stimulate an economy in a recession, they promise to reverse their stimulatory policies once the economy has recovered. Continuing to stimulate an economy with easy money once a recession has eased can lead to inflation and monetary policy-driven asset price bubbles. As a result of the emerging Delta variant, global supply chains that have seen prior opportunities for recovery have once again come to a standstill.

The RBI implements monetary policy by manipulating the repo rate, the rate at which banks borrow money from the RBI. Reducing the repo rate makes borrowing cheaper for banks and encourages them to lend more, boosting economic growth. The second tapering phase is characterised by the RBI increasing the policy rates. This is typically done gradually and calibrated so as not to disrupt the economic recovery. The third and final phase is when the RBI brings the policy rates back to the pre-crisis levels.

• The material contained herein is intended as a general market and/or economic commentary and is not intended to constitute financial or investment advice.
• Many economists and experts didn’t expect a repeat of the 2013 taper tantrum in 2021.
• Supporters of the move say that it was a necessary step to avoid inflation, while opponents argue that it could have negative consequences for the economy.
• The latest U.S.-China trade talks in Geneva and London offered little more than a diplomatic smoke break.

MoneyWeek

This makes it more expensive for people to borrow money and slows down the economy. The central bank will begin to taper when the economy is doing well, and inflation is under control. The central bank will start to raise interest rates and reduce the money supply.

So “tapering” simply describes a reduction in the amount of QE a central bank is doing. 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 what is arbitrage trading in forex does not involve selling the securities that the central bank purchased; it’s merely winding down the pace at which those securities are bought. This level of wage and price increase is seen as sustainably supporting a growing economy.

• Consequently, as goods become more scarce, a significant increase in commodity and retail prices looms over the economy.
• That leaves us with no reason to expect—absent monetary policy decisions that lead to a big move in the dollar—any reduction in the trade deficit from the tariffs.
• Tapering, in fact, anticipates what will happen shortly in economics and finance, namely the central bank’s lower propensity to purchase bonds.
• More demand means a higher price for debt securities and, as a result, a reduced yield.

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Tight, or contractionary policy is a course of action by a central bank to slow down economic growth, constrict spending in an economy that is seen to be accelerating too quickly, or curb inflation when it is rising too fast. The Fed tightens monetary policy by raising short-term interest rates through policy changes to the discount rate, also known as the federal funds rate. The Fed may also sell assets on the central bank’s balance sheet to the market through open market operations (OMO). Tapering refers to the period of reversal between expansionary policy and contractionary monetary policy.

Understanding Quantitative Easing

However, tapering the Fed’s asset-purchase program in December 2021 was the first significant step towards normalizing the monetary policy. Looking at the status quo, inflation rates have seen a YoY increase of 5.4%, surpassing  the Fed’s target of 2%. Therefore, the Fed enacts the tapering of securities purchases to counteract rising prices. However, as to ease concerns, the Fed also stated that it considers current increase in prices to be transitory – that is, current inflations are no more than a temporary byproduct of the pandemic. Tapering is the gradual reduction of central bank asset purchases to normalise monetary policy.

When the government buys assets, their prices go up, which lowers their yield or interest rate. Central banks, such as the U.S.Federal Reserve (Fed), can stimulate economic recovery by buying asset-backed securities. This process, along with maintaining a low interest rate, is called “quantitative easing (QE).” But central banks can’t endlessly purchase securities and pump money into the economy. When they believe the economy has recovered sufficiently, they work on winding down asset purchases or “tapering.” The Fed has made clear that tapering will precede any increase in its target for short-term interest rates.

This will slow the economy down and help to keep inflation under control. Tapering is usually done when the economy is doing well and inflation is under control. The central bank will start to sell some of its assets, like bonds, and use the money from the sales to pay down its debt. The entire process by the central bank in India can be broadly classified into three main phases. The first phase begins with the RBI giving clear signals about its policy intentions through its various policy statements. This is followed by the RBI gradually withdrawing the accommodative monetary policy measures it had implemented during the global financial crisis.

The central banks often use quantitative easing during periods of economic weakness or financial crisis. It involves purchasing government bonds or other securities from the market, injecting liquidity, and stimulating economic activity. However, as the economy recovers and strengthens, excessive monetary stimulus can lead to inflationary pressures and other risks to financial stability.

Purchases were reduced by a further $10 billion at each subsequent meeting (in February 2014, Janet Yellen took over as Fed Chair). The asset purchase program ended in October 2014, and the Fed began shrinking the balance sheet in October 2017. The Fed implements quantitative easing as one of its tools to stimulate the economy.

After the taper is complete, and assuming the economy continues to improve, Fed watchers are thinking about when the FOMC will raise the target range for the federal funds rate from its near-zero level (also known as “liftoff”). But as Fed Chair Jerome Powell has said, these are independent policy decisions; the timing and pace of tapering is not intended to signal anything about the timing of interest rate liftoff. The FOMC’s first action may be to lower its target range for the federal funds rate, which is the interest rate that banks charge each other for overnight loans. Lowering the target range puts downward pressure on short-term interest rates, which encourages spending by consumers and firms. Treasury securities and agency mortgage-backed securities each month during the COVID-19 pandemic, aiming to support the flow of credit to households and businesses during this time of severe stress in the economy. However, long-term rates also reflect market expectations about the course of short-term rates.