Tapering’s Impact on the Markets

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1. Tapering is the process of reducing the pace of quantitative easing (QE), but the balance sheet is still being expanded, though at a slower rate.
2. Since the prices of financial assets—particularly debt instruments such as bonds, but also stocks—tend to be inversely related to interest rates, critics of QE worry that it has created asset price bubbles.
3. While his tax cuts were a stimulant, his tariffs on imported steel, a signature policy, probably cost the country more jobs in manufacturing than it gained in steel, at great expense to American consumers.
4. Our banking reporters and editors focus on the points consumers care about most — the best banks, latest rates, different types of accounts, money-saving tips and more — so you can feel confident as you’re managing your money.
5. There are no guarantees that working with an adviser will yield positive returns.
6. Powell's general tone during this post-meeting news conference surprised Jones.

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Why the Fed is about to taper

Powell stressed the Fed will move carefully before raising rates and likely will wait until tapering is complete, but the market will be watching for more hawkish indications. If the taper indeed begins in December, reducing the purchases by $15 billion a month would get the process down to zero in eight months, or July. In light of the role the program has played, Fed Chairman Jerome Powell assured the public Wednesday that "policy will remain accommodative until we have reached" the central bank's goals on employment and inflation. 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. Indeed, as noted above, the Fed has been sending out signals about tapering for much of 2021.

Muted Response of the Markets

In other words, the Fed (or any central bank) shrinks its monetary reserves by either selling Treasurys (government bonds) or letting them mature and removing them from its cash balances. A recent example of tapering can be seen in the US at the Fed after the 2008 global financial crisis. In June 2013, Ben Bernanke, the Federal Reserve Board Chairman at the time, announced that the Fed would begin tapering and reduce the amount of its asset purchases. Then in January of 2014, the Fed started tapering by $10bn per month from $85bn to $75bn, with the intent of ending the QE program around the middle of 2014. Stock markets fell, US domestic interest rates rose and risky assets, such as Emerging Market debt and equity weakened. 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.

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There is also the issue of whether it is the stock of QE bond holdings or the flow of monthly purchases that is more important in keeping bond yields low. The prevailing view is that it is the size of the central bank balance sheet that matters most, with studies suggesting that the Fed’s stock of QE purchases has reduced long-term US yields by around two percentage points. Although bond yields appear too low relative to the strength of the economy, several factors are likely to work against a sharp rise as the Fed dials back its purchases during the coming months. Real (i.e., after inflation) yields could edge higher, but are likely to remain negative.

QE in 2020

Taper, however, is not to be confused with selling assets and shrinking the balance sheet. Rather, the Fed is simply gradually reducing over a certain period of time how much it’s buying. Federal Reserve began tapering, American investors in India began withdrawing their funds since higher interest rates in the U.S. gave them a better return on their investments. As foreign investments withdraw, the rupee’s value plummets and depreciates by a large percentage. The strengthening of the U.S. dollar has led to an increase in the incidence of inflation in India. This initiated the phenomenon known as the Taper Tantrum, an investor exaggeration that nearly ruined developing countries.

These asset purchases are frequently seen in quantitative easing (“QE”) policies whereby central banks look to inject liquidity directly into fixed income markets in order to drive yields lower and reduce the overall cost of borrowing. QE purchases in equities and ETFs, on the other hand, are not just meant to reassure markets but make investors move out of these assets into other risk assets, such as emerging markets, loans, and real estate. The Fed’s QE programme, along with those of other central banks, has played a key role in keeping government bond yields low and encouraging capital flows into more risky assets such as corporate bonds and equities. In turn, elevated asset prices are in part justified by the assumption that long-term bond yields will remain low for an extended period. Investors are concerned that the withdrawal of QE could result in a reduction in liquidity and/or a rise in bond yields which could trigger falls in equity markets.

During his press conference on Nov. 3, 2021, Fed Chair Powell insisted that, despite tapering, the Fed's stance will remain "accommodative," still seeking to keep interest rates near zero. "It would be premature to raise rates now," he said in response to a subsequent question about inflation. 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. Nothing contained in or on the Site should be construed as a solicitation of an offer to buy or offer, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction. SSGA Intermediary Business offers a number of products and services designed specifically for various categories of investors.

How will Fed tapering impact the stock market?

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. Rather than $15 billion, the Fed will reduce purchases by $30 billion every month. When credit is tight, prices are not increasing much and jobs are scarce, increasing monetary stimulus helps make it easier to borrow money and encourages consumers to spend and businesses to hire.

The U.S. stock market fared excellently, although the impact on Indian markets was negligible. From 2013 to January 2020, the Sensex grew by 105 percent (just before the pandemic). A central bank can carry out tightening by lifting short-term interest rates by changing the federal funds rate or removing excess liquidity from the market by selling assets it holds.

This would align with the Fed’s goal of having the balance sheet exclusively comprised of Treasuries. Running off mortgage-backed securities (MBS) and reinvesting in Treasuries actively lower the MBS’ share of balance sheet even if the overall balance sheet is no longer shrinking at the same rate. The current environment makes it easier to focus 100% of reinvestment in Treasuries because the MBS market is much less negatively convex than in the past. The case for slowing QT by focusing reinvestments solely on the Treasury market is strong. When an economy is strained, that is, when the government perceives a liquidity shortage, the central bank purchases a fixed quantity of government bonds and other assets to inject cash into the economy.