The short answer: money is essentially free now, thanks to the Fed’s double-barrel shotgun approach to economic stimulus: near-zero interest rates and a massive investment in bonds that keeps the yields close to the bottom. If the Fed releases the stimulus pedal, debt can rise and make companies pay more, which means less profit, which means Wall Street is sad.
The talk about volume reduction will only accelerate this fall, and while it may seem a bit academic, the results of the Fed’s decision could have a big impact on everyday people, especially those who want to buy a home. or run a business.
To understand how we got here, we have to go back to March 2020, when the Covid-19 landed like a bomb on the shores of the United States. Businesses closed, at least 20 million people lost their jobs in a single month and Wall Street was in total panic mode. In just under a month, the S&P 500, Wall Street’s largest measure, lost more than 30% of its value. If you looked at your retirement account during that time, it was a bleak sight.
While Congress was debating what to do, the Federal Reserve basically threw itself on the Covid bomb to prevent a total economic and financial collapse. He did it by buying debts with the government, a lot of them.
Without going too far into squandering the Fed’s balance sheet, what we need to understand here is that much of the central bank’s job is to ensure stability, and it does so by controlling the amount of money saved. When buying the debt, the Fed was essentially activating a currency of money.
And it has maintained that for the past year and a half, to the tune of about $ 120 billion a month in Treasury bonds and mortgage securities.
With this easy money supply, investors returned from the limit in the spring of 2020. In April, the stock market began to rebound, even as the economy as a whole plunged further into the crisis and worsened. the public health crisis. This disconnect between Wall Street and Main Street persists in part because the Fed has kept interest rates close to zero and has assured investors that it will continue its easy money policy for as long as it takes to get the economy back on track.
Pump the brakes
The good news is that economic recovery is achieved as he is vaccinated, returns to work, and in many ways resumes his pre-pandemic life. This means it’s time for the Fed to liquidate or reduce its debt purchases.
It’s a delicate process and Fed Chairman Jerome Powell has been cautious and sometimes cryptic about how and when the taper will start. Pulling the brakes would cause panic for the investor, but not stopping it would fuel inflation.
Avoid a “taper rage”
The Fed is clearly trying to prevent the recurrence of the so-called 2013 rage.
At the time, the Fed triggered the panic by simply mentioning its plans to eventually reduce purchases of Treasury bonds, a policy known as quantitative easing or QE, which is just a nerdy way of saying pumping money into the economy. The Fed began its QE policy in response to the 2008 recession and investors became accustomed to easy money.
The mention of a future taper surprised bond investors and they began selling massively. Bond prices plummeted, which meant an increase in yields (which move inversely to prices).
High bond yields lead to higher mortgage rates. They make the growth of companies more expensive by taking on debts. This is bad news for a recovering economy, and exactly the scenario the Fed is trying to avoid.
When will the Fed withdraw?
On Friday, in his long-awaited speech at the Jackson Hole virtual symposium, Powell was optimistic about the reduction in volume before the end of this year, but tempered that optimism with a few words of caution: The Delta variant remains a threatening threat. brings it closer to the American economy.
By now, a fallen taper shouldn’t surprise anyone on Wall Street. The stock market seemed to take it easy on Friday’s narrow talk: US stocks were in the green, with the top three stock indices adding up modest gains after Powell’s speech. The yield on the ten-year Treasury bond fell by 0.02% to 1.32%.
– Anneken Tappe of CNN Business contributed to the reports.