Tapering is one of the Fed’s policies, to control the rate of inflation. The Fed decides on a tapering policy if the economy has shown signs of improvement. After being given monetary stimulus with quantitative easing.
However, several emerging countries criticized the policy. The reason is when the Fed did tapering. The financial world face a symptom called a taper tantrum. Because the Fed is the central bank that issues dollars, which are used throughout the world as foreign exchange reserves.
Almost all policies regarding the circulation of the dollar will have an impact on the economies of countries in the world.
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Contents
Tapering off the Fed meaning
Tapering is reducing gradually the purchase of assets in quantitative easing.
The Fed is the central bank of the United States which has the authority to regulate and issues the money supply, which is closely related to inflation.
One of them is by tapering. The term tapering being popular when Federal Reserve Chairman Ben Bernanke stated before Congress that the Fed could reduce, or taper, the size of its bond-buying program known as Quantitative Easing (QE).
Quantitative easing
In short, quantitative easing is the Fed’s policy to accelerate the pace of US economic recovery after being hit by a crisis or recession.
That is by injecting money into the public by buying bonds on a regular basis per month. During a crisis, the Fed buys long-term bonds so that corporations and banks have money to circulate.
The Fed buys bonds such as government bonds and mortgage bonds. The money became an economic stimulus for the recession-hit United States.
The Fed did this in 2008 when the country was hit by a crisis. This policy was also carried out during the COVID-19 pandemic, where the Fed was keen to buy debt securities worth US$120 billion per month.
But on the other hand, if the money supply increases, inflation can increase and lower the US dollar’s own exchange rate.
If the value of the currency weakens, the Fed will need to reduce purchases of debt securities in order to prepare for more stable economic growth. This reduction in asset purchases is known as tapering.
How does tapering off works
The Fed in this case is the central bank, in realizing the tapering policy. They always communicate with investors about the decision of central bank policy. It has to do with future programs to help set market expectations and reduce market uncertainty.
To reduce this uncertainty, the Fed applies tapering gradually. The Fed does not suddenly stop its expansionary monetary policy, because it can lead to unstable market conditions.
Central banks are always trying to make their approach to tapering. It aims to describe the specific conditions to decide whether tapering will continue or be discontinued.
The Fed will communicate everything in list quantitative easing to investors so they can adjust before the tapering actually happens.
Before doing so the central bank will announce its plans to slow down asset purchases and sell or allow assets to mature. The aim is to reduce the total amount of central bank assets and, hopefully, to control the money supply to reduce inflation.
Reasons tapering off the Fed
The main reason the Fed does so is to suppress inflation. This is one of the Fed’s options in addition to other policies to reduce the high inflation rate.
Another policy of the Fed to control inflation is to increase the benchmark interest rate. Like most central banks, when inflation occurs, they will raise the benchmark interest rate in the hope that investors will prefer to save more money in the bank than spend it.
The Fed taped back in 2013 after the monetary authority pocketed US$4.5 billion in debt securities. But the policy turned out to cause an event that many people refer to as the Taper tantrum.
For this reason, the Fed will implement a tapering policy in stages until the bond purchases can be completely stopped. Because if there is too much stimulation, the economy will ‘overheat’.
In its efforts to restore stimulus, the Fed is doing it carefully. This is because market expectations often trigger fluctuations in the global economy.
What is the impact of tapering off to the market?
Although the Fed is tapering very carefully and communicating with investors, looking at past history, the impact of tapering off is a taper tantrum.
The moments occurred in 2013 when the Fed’s tapering policy triggered a panic from market players where many foreign investments that at that time dominated the capital market were withdrawn.
The tapering policy is a monetary move that has triggered trauma for most countries into a move that has sparked debate among bankers, according to a Bloomberg report.
What is a taper tantrum?
The taper tantrum is the effect of the Fed tapering off. Tapering off the Fed could cause capital flows to leave emerging market countries and return to the US, thereby triggering financial market turmoil.
The Fed scheduled tapering off because it is considered the economy has started to recover. Simply put, if the US economy improves, it will usually be followed by an increase in inflation and yields or yields on US government bonds (US Treasury).
This will make foreign investors choose to leave the financial markets of emerging market countries, and return to the US because they are considered to have better yields.
Taper Tantrum Signal
Many factors prompted the Fed to tighten monetary policy, which could lead to a taper tantrum. But the most common signal can be seen from two main indicators, namely inflation data and US treasury yields.
For example, US treasury yields have now risen to the range of 1.6%. In fact, it is estimated that it will still climb to the level of 1.9%.
Meanwhile, US inflation continues to rise. In April, US inflation hit 4.2%. These are signs that have been seen after the government provided a jumbo stimulus worth USD 1.9 trillion which was distributed to the population.
Another signal is to follow the press by Fed governor Jerome Powell hinting he will taper. in this case, The Fed will open to communicate with investors before making a decision.
Impact on the market
The depreciation of the balance sheet due to tapering is essentially throwing billions of dollars of bond holdings back into the market. It may raise long-term treasury interest rates.
Other potential effects included from tapering off include:
- Quantitative tightening could contribute to a rise in mortgage rates. As investors worry about inflation they buy fewer bonds. •
- Panic feelings about quantitative tightening among investors could add to stock market turbulence.
How does tapering off the Fed affect currency?
In 2021, many analysts have begun to predict that the Taper tantrum will happen again repeats the history that happened in 2013.
CNBC reports that inflation in the United States is getting higher. This is as a result of quantitative easing by the Fed during pandemic causing the money supply to be higher.
The Fed has raised its inflation forecast for this year from 1.8% to 2.4%. That is, the possibility of the US benchmark interest rate rising faster. According to FOMC member’s talks, there is a possibility that the benchmark interest rate could be raised in 2023 than previously projected in 2024.
This step is going to be faster than projected of course. In addition to the benchmark interest rate, tapering off or tightening of asset purchases is also an issue that is being considered, especially in emerging countries.
In the 2013 taper tantrum, it gave an early warning to emerging countries, to prepare for the possibility of the disaster happening again in 2022.
At that time, many investors bought dollars again because they were looking for higher yields, as a result, the emerging country currency weakened against the USD.
If the Fed finally raises interest rates in 2023, there is a possibility that investors in emerging countries will withdraw their funds and buy USD because it will provide higher yields with rising interest rates. That can cause the USD to be strongest against emerging market currencies.
Meanwhile, if the Fed does not increase interest rates and there is no tapering off. Hence the United States could experience a high rate of inflation due to the growing money supply while recovery has not yet been achieved.
How does tapering off the Fed affect stocks?
In the 2013 taper tantrum, the Dow Jones Industrial Average (DJIA) only experienced a temporary decline. There is a reason for this because the treasury bill had an effect on the stock market, but the Fed did not really slow QE purchasing, launching three rounds of bond purchases. And the step did not cause a panic investor in the stock market.
However, a taper tantrum can affect the emerging country’s stock market, as a result of withdrawing funds to buy USD. For example, in 2013 the JCI is an index of Indonesian stocks which is one of the emerging countries. Dropped about 20% as a result of a taper tantrum.
What does tapering off the Fed mean for gold?
Maybe there is no uniformity of analysis between one analyst and another about the effect of tapering on gold. There are analysts who stated that tapering off can affect gold prices to be bearish.
There are several assumptions to be the reason investors sell gold.
- Since the economy is already on a recovery, people no longer need gold to hedge.
- Or because people prefer to get yields from rising treasuries rather than gold.
Hebba Investments analyst
But the analyst from Hebba Investments, that tapering is actually good for gold. Of course, this is an analysis that differs from the general view, but it has several reasons for it. Some of the reasons are as follows:
- At the time of the announcement of Quantitative Easing. It was not positive for gold, people did not buy up gold.
- Gold gets the biggest gain without quantitative easing. In 2001 at a gold price was under $300 per ounce, and proceeded to rise to over $1000 before Quantitative easing.
- The tapering signal as a strong economy is not needed by Gold. It can increase even in recovering economy.
Sunshineprofits analysts
In contrast to analysts from Sunshineprofits. The taper tantrum caused gold prices to plummet after Bernanke announced the tapering off at a press conference.
The reason for the decline in prices was due to the panic of the market. As a result, that tapering was a good sign of recovery. And interest rates and strong dollars caused gold to drop.
Tapering is one of the Fed’s policies, to control the rate of inflation. The Fed decides on a tapering policy if the economy has shown signs of improvement. After being given monetary stimulus with quantitative easing.
However, several emerging countries criticized the policy. The reason is when the Fed did tapering. The financial world face a symptom called a taper tantrum. Because the Fed is the central bank that issues dollars, which are used throughout the world as foreign exchange reserves.
Almost all policies regarding the circulation of the dollar will have an impact on the economies of countries in the world.
History tapering off the Fed
Historically, the Fed will carry out a massive stimulus when the economy is a downturn. The pandemic that hit caused chaotic economic conditions as a result of the lockdown and caused several countries to face recession.
This step was taken between 2008 and 2009 because banks were no longer giving credit. Because they are afraid that they will not be repaid due to the crisis. At the lowest interest rates, the absorption of money decreases, and the Fed purchases Treasury bills, bonds to inject liquidity into the financial system.
That’s actually the Fed does not print real money, in America. The money supply is digitally credited and debited through banks. It was only when banks lent money that they were created.
Referring to an Economictimes article, since March 2020 the Fed started buying Bonds worth $120 billion. And it increased by $7.8 trillion as of April 14, 2021.
The discourse on tapering began when Jerome Powell’s press conference said it could reduce asset purchases this year.
Final thought
The current tapering of the Fed by some analysts is considered different from 2013. The impact of the tapering tantrum may be anticipated by emerging countries such as India, Turkey, or Indonesia. Because it has learned from the events of 2013 so that the impact can be more minimal.
If read about the current update of the pandemic in the United States, it seems that the economy has not fully recovered. So a reasonable reason for the Fed to taper off is to suppress inflation because there is too much money supply.
Note: This article is only information and some personal views, this is not investment advice, all risks in investment are the responsibility of each investor.
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