The U.S. Federal Reserve announced it would begin tapering in November – and it remained true to its word. Now the country’s central bank has begun that process. But what exactly does tapering mean and how can its impact on the economy pop America’s speculative asset bubble?
According to Investopedia, “tapering is the theoretical reversal of quantitative easing (QE) policies, which are implemented by a central bank and intended to stimulate economic growth. Tapering refers specifically to the initial reduction in the purchasing of and accumulation of central bank assets.”
In other words, tapering occurs when the Federal Reserve starts slowing the pace at which it is acquiring assets, which it normally beefs up during financial crises like the covid-19 pandemic “to lower long-term interest rates, keep financial conditions loose and help spur demand,” Reuters reported.
The central bank begins to slow the pace when it believes the economy is beginning to rebound and purchasing assets at an increased rate will do more harm than good.
Federal Reserve Chair Jerome Powell said the U.S. central bank could actually move more quickly through the process than initially forecast.
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“At this point, the economy is very strong and inflationary pressures are higher, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner,” Powell told a Senate committee on Nov. 30, CNBC reported. “I expect that we will discuss that at our upcoming meeting.”
The Federal Open Market Committee (FOMC) initially said the Federal Reserve would stop buying bonds and mortgage-backed securities (MBS) to the tune of $15 billion per month in November and December ($10 billion in Treasurys and $5 billion in the MBS).
With inflation continuing to spike and no sign that spending will stop, Powell said the increased bond-buying is not as necessary now as it was at the start of the pandemic. He also reversed his position that inflation was “transitory” acknowledging that supply chain disruptions and increased spending are likely here to stay for a while.
“The need for that has clearly diminished as the economy has continued to strengthen, as we’ve seen continued significant inflationary pressures, and that’s why we announced that we would taper, and it’s why we’re now saying we’re going to discuss a somewhat faster taper at our next meeting,” Powell said.
The announcement has caused concern and panic among stock market investors and financial experts who believe the tightening by the central bank can pop the speculative asset bubble.
“Fed tapering will hurt markets all over the world, not just the US. It will lead to tighter financial conditions, greater volatility in markets and less leverage running through the overall system,” Mott Capital Management explained. “It will lead to the unwinding of many of these risk-on trades and to a massive amount of PE contraction in equity markets, which is precisely what happened in the last tapering cycle, when financial conditions continued to tighten through 2015, leading to the PE on the S&P 500 contracting to 15.1 from 17.3.”
KeyAdvisors Group managing partner, Eddie Ghabour agreed. “The longer you delay the tightening process, the hotter inflation gets and the bigger hit the consumer is going to take and then ultimately the market at some point in time,” Ghabour told Yahoo Finance.