Tag Archives | FED

Tapering

The most talked about piece of ‘financial tailoring’ ever began on the 18th of December when the Federal Reserve announced that it was reducing the size of bond purchases by $10 Billion from $85 Billion per month to $75 Billion. What does all this mean?

The Federal Reserve is tasked with trying to ensure that the economy runs in a sweet spot without overheating or slowing down too much. It measures how over or under heated the economy is doing primarily by monitoring inflation and employment data. Traditionally it has controlled the economy  primarily by adjusting interest rates, when an economy is going too fast it raises interest rates to slow it down and vice versa. During the financial crisis the Federal Reserve dropped interest rates from around 5% to eventually a range of 0-0.25% in December 2008 exactly 5 years ago. Using the traditional tool of interest rates this was as low as it could go. But in 2008 the economy was still in dire straights with unemployment rocketing and the share market plummeting so what could they do?

So the Federal came up with a plan known as quantitative easing which means that it essentially prints money to buying US government Bonds and mortgage securities which will increase the supply of money flowing around and hopefully stimulate the economy in the process. This program is what earned Mr Bernanke the nickname of Helicopter Ben sending piles of money down from above onto the US economy. The last of these programs QE3 was implemented in September 2012 and rather than setting a fixed amount of asset purchases set a target of $85 Billion each month that was contingent on economic data improving. In June, Bernanke mentioned that the data was looking better and that it was a possibility that the Fed might scale back, or taper,  their QE3 purchases later in the year. This sent the market down about 4% in 3 days, however it quickly recovered. The news of the actual tapering beginning in January was in contrast greeted positively by the market, perhaps caught in a good mood in the leadup to Christmas.

 

The good news behind the taper is that the Fed, which has been conservative in its assessment of the American economy, now has the confidence to essentially take their foot slightly off the accelerator. In other words they are positive about the prospects for the economy going forward.

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