‘Tapering’ – Why Should You Care?
With a new and unpredictable coronavirus variant contributing to a continuing anxiety in global markets, The US Federal Reserve (commonly known as, ‘The Fed’) has sought to calm investor nerves once again about ‘tapering’.
So how exactly does one define this curious phrase? Here, Sterling Asset Management Limited’s Eugene Stanley helps define this long-used but not-greatly-understood financial term.
Tapering is a term that actually gained a lot of traction around about 2012-2013. The Fed, responding to the 2008-9 financial crisis, bought bonds from the money market – in a program that was called ‘Quantitative Easing’ (‘QE’). Essentially, it provided liquidity in the market by printing extra money. This was rolled out by the US government buying bonds from the marketplace on a ‘temporary’ basis.
This would have occurred from about 2010-13. Tapering back in 2013 was seen as a problematic word for investors but now that markets have seen how tapering has transpired, we continue to see a general improvement in both stocks and bond prices.
Never meant to be a permanent situation, governments, at some point, would have had to cut back on those purchases eventually and ultimately cease their operation. The markets though soon became accustomed to the practice. Remember that markets are almost by definition, dynamic, so they soon adjusted.
‘Tapering’ is, therefore, the gradual reduction of those monthly governmental purchases. If you like, the official cessation of the artificial government stimulus that was enacted during the pandemic. Those purchases should eventually round down to zero. A monthly US$120bn bond amount has been purchased by the US Federal Reserve since around March 2020 as a consequence of the Covid-19 pandemic.
“As an investor, how tapering affects you is largely dependent on what type of investment you hold with us.” Eugene Stanley, Fixed Income & Foreign Exchange at Sterling Asset Management.
When tapering was first introduced in 2013 it was a novel idea. Markets didn’t really know what it would mean or what would happen. Markets tend to look at tapering negatively for the assets an individual holds in the market. For stocks it may result in some correction of overvaluation, as their value may need to be adjusted once the Fed begins to reduce liquidity from the financial system.
For bonds, higher benchmark rates usually translated into higher bond yields, so investors would ask for higher rates of return which meant that the price for existing bonds would fall. So persons who own bonds would see the value of their existing portfolio fall, as well, but they may also be able to acquire additional bonds at higher yields thus improving the overall income available from their portfolio.
However, you should be an investor concerned about the medium to the long-term. Short term movements in interest rates or the price of assets, which generally improve over time – as long as you’re invested in high quality assets – meaning you shouldn’t be too concerned about the fluctuation in short-term prices.
The Fed has recently announced that they will reduce tapering by around US15bn per month. So from US$120bn to US$105bn. Now, for most people when talking about the world’s largest economy that may not sound like a great deal of money but consider that since March of 2020 over US$1tn has been pumped into the US economy. With an upcoming expectation that The Fed may double the pace of QE reduction by as much as US$30bn per month this December, we may be looking at a cleared government account by mid-Q2 2022, of course, barring any unexpected global eventuality.