The Federal Reserve utilized a tool called quantitative easing in 2020 when Covid-19 shutdowns crashed the economy. You may remember this FED response during the 2008 housing crisis, when the housing market collapse caused an economic disaster, and the FED used quantitative easing to support the economy until markets stabilized.
Quantitative Easing is a method that the FED uses to push cash into the economy and financial markets by buying debt instruments, or bonds. Many of the bonds that the FED buys are Treasury Bonds and MBS’s or Mortgage-Backed Securities. According to Brookings.edu, the FED has been buying $80 billion in Treasuries, and $40 billion in MBS's per month to artificially inflate the economy after the impact of the Covid-19 lockdowns.
Quantitative Easing does several things. It makes cash more available for borrowing and pushes down interest rates, to make lending affordable to more people and businesses. It also has a negative impact when abused. The quantitative increase of cash into the economy causes a rapid increase of inflation, or the devaluation of the dollar. This means the dollar is less valuable when making a purchase, and it often causes prices to rise, since it requires more dollars to purchase goods.
It can also have a negative affect on wages if QE continues too long. Wages cannot keep up with out-of-control inflation, and artificially low interest rates. Wages remain numerically the same, but the purchasing power of wages decreases. This makes basic necessities, such as food and energy costs, become more expensive.
In 2020, the FED began Quantitative Easing on a massive scale, pushing interest rates to nearly 0. Today we are seeing inflation reach very high levels, which is why we are starting to see the value of goods increase significantly. As of May, 2021, the U.S. Bureau of Labor Statistics reported that the consumer price index increased by 4.2%. This means your wages became 4.2% lesser in value.
When the FED says they are going to taper the Q.E., it means they are going to buy less bonds, which will slow the flow of money into the economy, and push interest rates higher, restricting the amount of dollars flowing into the economy, lowering inflation. However, if the economy is doing well, it should not have an extensive negative impact on the economy. However, a retraction during a recession could hurt. In the case of a flash recession, or unexpected recession in the economic cycle, the FED would eliminate the taper.
According to media reports, including CNBC[1] and Reuters[2], the FED is probably planning to announce tapering in September. (This will be an announcement, not the actual tapering itself). No one can be sure when the taper will start.
We are seeing the FED consider tapering the QE because they believe the economy is strong. There are more jobs than unemployed people as of August, 2021[3] .
The economy is still strong from the deregulation and lowered taxes done by the Trump administration, and we're still seeing one of the greatest economic expansions since World War 2. The FED seems to be assuming nothing will be changed on this with a 50/50 split in the Senate, however, the recently passed HR 3684 Infrastructure Investment and Jobs Act, could change that.
The recently passed $3.5 trillion House bill is set up to go into a Senate process called "reconciliation" in which it is said that Democrats are contemplating tax increases and regulations that could undo certain policies that led to the economic expansion. If this happens, the FED will be forced to continue Quantitative Easing, stop the taper, and inflation would most likely take an axe to the growth of the US economy and people's wallets. Jobs could once again go overseas to countries with lower corporate tax rates, there would be middle class job loss, and prices of everyday goods would substantially continue to rise. In this circumstance, the FED would have to allow a depression, in order to save the QE tool for the future (to protect people from inflation), or they would use QE further, and put America at risk of a more serious economic decline should a recession happen during quantitative easing, eliminating the usefulness of the QE tool.
The current concerns that many investors have with an upcoming taper are coming from the memories of the 2013 so-called “Taper Tantrum” when the FED tapered it’s QE. It resulted in a temporary decline in the markets. This decline was short term, lasting several months. But always remember the investment rule: past performance does not predict future results.
What should we reasonably expect? We can expect that when the FED starts to taper QE, interest rates will rise, causing a decrease in the price of existing bonds. If the markets react, we will see a decrease in the markets. We do not know how much of for how long, but if the economy stays strong, it should be temporary.
There is no way to predict what will happen. What we must plan for accordingly, is searching for investments least impacted by FED tapering. We must also disclose that no investments, be it stocks or bonds, or others, are without risk. Hopefully, any decline will be short-term.
We must also remember, that this is a necessary step for the FED to take. If they do not, it could lead to harsher consequences of unchecked inflation, and an inability for the FED to take action in the event of another housing crisis, or Covid-like shutdown. The most concerning is the policy that the current Congress and Administration are contemplating and what they can pass into law. High business regulation and higher taxes, even on corporations, is always historically detrimental to economic success. Here at AFS we are continuing to keep watch on economy and on your investments.
If you have concerns, or would like to discuss your options, please call us.
[1] https://www.cnbc.com/2021/08/18/as-fed-nears-taper-theres-plenty-of-uncertainty-for-market-economy.html
[2] https://www.reuters.com/world/us/fed-unveil-bond-buying-taper-plan-next-month-jobless-rate-fall-slowly-2021-08-13/
[3] https://www.cnbc.com/2021/08/07/there-are-about-1-million-more-job-openings-than-people-looking-for-work.html