In a surprise move, the Federal Reserve decided to begin tapering—albeit a “tiny taper” of $10 billion—at its December FOMC meeting. The decision follows its stunning announcement back in September not to pare its asset-purchase program. It also surprised the market by tapering an equal portion of government securities and mortgage-backed securities.
Starting in January, monthly purchases of government securities will be 11% lower than the current level ($40 billion versus $45 billion.) And purchases of mortgage-backed securities will be 12.5% lower than the current level ($35 billion versus $40 billion.)
In its prepared statement, the FOMC cited its belief that economic growth is improving enough to begin reducing quantitative easing. Specifically, the Fed has presided over a substantial drop in unemployment—from 7.8% to 7%—since QE3 began in September 2012.
Further, the Fed may have grown more comfortable with tapering because the recent budget deal in Washington removed two key headwinds: another government shutdown and a fiscal drag in 2014 stemming from thesequester.
However, significant issues still remain—some of which Fed chair nominee Janet Yellen has cited in recent months—so it’s likely that the taper will be gradual:
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The labor-market recovery remains flawed with a low labor-force participation rate and a high percentage of unemployed Americans who have been out of work for 27 weeks or more. |
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Anemic pricing as seen in both the recent PPI¹ and CPI² numbers, which suggest there’s a threat of deflation. |
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Despite the budget deal, there’s still some uncertainty around the debt-ceiling debate this spring. |
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Yellen has cited a “third objective” of the Fed: maintaining the stability of financial markets. A gradual tapering could be crucial to ensuring that stability. |
Here are three key takeaways for investors:
1Think of tapering of quantitative easing as a dial. Just as people adjust their thermostats, the Fed will likely be adjusting QE based on the strength of economic data. But don’t expect a huge change in stance once Yellen takes the helm, especially given that she voted for tapering to begin.
2It’s a vote of confidence for the economy. The Fed has said it would not start reducing support until it believed the economic recovery had legs.
3Most importantly, expect monetary policy to be looser for longer. The Fed will likely remain very accommodative even though tapering has already started.
¹ Producer Price Index
² Consumer Price Index
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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