Tapering, explained: Why the Fed is ending the party on Wall Street
The short answer: Money has been essentially free for a year and a half, thanks to the Fed’s double-barreled approach to economic stimulus – near-zero interest rates and massive investment in bonds that keeps yields low. When the Fed releases the stimulus, borrowing could get more expensive, forcing companies to pay more, which means less profits, which means Wall Street isâ¦ sad.
While it may sound somewhat academic, the results of the Fed’s decision could have a huge impact on ordinary people, especially those looking to buy a home or run a business.
The coronavirus crash
To understand how we got here, let’s go back to March 2020, when Covid-19 landed like a bomb on American shores. Businesses closed, at least 20 million people lost their jobs in a single month, and Wall Street was in a state of panic. In just under a month, the S&P 500 – Wall Street’s largest metric – has lost more than 30% of its value. If you were brave enough to take a look at your retirement account during this time, it was a grim sight.
As Congress argued over what to do, the Federal Reserve essentially threw itself on the Covid bomb to prevent a total financial and economic collapse. It did so by buying government guaranteed debt, in large part. Without getting too much into the weeds about the Fed’s balance sheet, what needs to be understood here is that much of the central bank’s job is to provide stability, and it does so by controlling the amount of money that is circulating. By buying out debt, the Fed was essentially running on a money tap.
And it has continued ever since, to the tune of about $ 120 billion a month in treasury bills and mortgage-backed securities.
With this easy money offer, investors came back from the precipice in the spring of 2020. In April of the same year, the stock market began to rebound, even as the broader economy faltered and the public health crisis. was getting worse. This disconnect between Wall Street and Main Street persists in part because the Fed has kept interest rates close to zero and assured investors that it will continue its easy money policy for as long as necessary to put the money back. economy on track.
The good news is that the economic recovery continues as more people get vaccinated, return to work and, in many ways, get back to their pre-pandemic lives. This means that it is time for the Fed to cut or reduce its debt purchases.
It’s a delicate process, and Fed Chairman Jerome Powell has so far been cautious, and at times cryptic, about how and when the reduction might begin. Slowing down would trigger panic among investors, but not slowing down would fuel inflation.
Avoiding a “temper tantrum”
The Fed is clearly trying to avoid a repeat of the so-called 2013 tantrum.
At that point, the Fed triggered a panic by simply mentioning its plans to possibly reduce its purchases of Treasury bonds – a policy known as quantitative easing, or QE, which is just one way. elegant to say inject money into the economy. The Fed began its quantitative easing policy in response to the 2008 recession, and investors have grown accustomed to the easy money.
At the time, the mention of future tapering caught bond investors off guard and they started selling en masse. Bond prices have fallen, meaning that yields (which move in the opposite direction of prices) have skyrocketed.
High bond yields lead to higher mortgage rates. They make it more expensive to grow businesses by going into debt. This is very bad news for a recovering economy, and this is exactly the scenario the Fed has sought to avoid this time around.
What is happening now?
The Fed said on Wednesday that it would start cutting asset purchases by $ 15 billion per month, starting this month. If it maintains this pace, the program will end completely by the middle of 2022.
This news should come as no surprise to Wall Street, as the central bank has been warning investors for months that it will do so before the end of the year.
There was no immediate “tantrum” in the market after the Fed’s announcement: in fact, major stock indexes edged up Wednesday afternoon, even though stocks were only moving in low. modest forks.
By removing some emergency support for the economy, the Fed hopes to keep high inflation under control.
The Fed will keep its target interest rates close to zero. And he said he was ready to slow the pace or reverse its decline if the economic outlook changed.
– Anneken Tappe of CNN Business contributed reporting.