First, let’s rewind to March 2020: The global capital markets were being rocked by the pandemic. Volatility was extreme, and many assets were hemorrhaging in value. During a black swan event like this, the Federal Reserve has many tools at its disposal to stabilize market functioning–which is one of their main purposes.
Cutting interest rates is one way to propel the financial system upwards. Lower rates spark economic activity and purchasing, such as with homes, cars, and spending on other goods and services. However, rates had already been near zero for an extended period, so the pandemic called for a more robust measure. Enter Fed bond-buying.
When an economy is in the midst of an extreme downturn, banks are less willing or completely unwilling to give loans in fear of borrower default–meaning money isn’t flowing as much as in other times. By the Fed purchasing bonds, money is injected into the economy, driving interest rates lower and creating liquidity. Borrowing costs decrease, bank lending is incentivized, and economic growth is sparked. This bond-buying is also known as quantitative easing.
Starting in March 2020, the Federal Reserve began purchasing $120 billion in assets every month to counteract the pandemic’s blow to the economy. The monthly asset purchases were allocated into $80 billion of Treasury securities (bonds, notes) and $40 billion of mortgage-backed bonds. This plan was created to prevent a health crisis from turning into a financial crisis.
Now, let’s turn back to the present: The Fed’s bond-buying has been in force for over a year and a half. Its purpose has been served–asset prices were stabilized and even soared (think stocks and real estate). Long-term interest rates were pushed even lower as a result, enabling homeownership at low borrowing costs. And as can be a downside of bond-buying, higher inflation took root.
The Fed thinks it is now time to reduce the bond-buying gradually and allow the market to stand on its own two legs. This process is known as the tapering of asset purchases; it’s the gradual undoing of the bond-buying stimulus.
The tapering process has to be executed with a fine-toothed comb to avoid market volatility or a taper tantrum, as we saw in 2013. Keep in mind that the Fed will still be purchasing assets, just at an increasingly reduced amount over a period of time. Interest rates are still extremely low historically, so monetary policy is still on the very accommodating side.
As Fed tapering approaches, we will pay close attention to the stock market and keep you apprised of any developments. As always, should you have any questions or concerns, please feel free to give us a call or email us anytime.
The Trademark Capital® Team
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