MARKETS IN A MINUTEExplainer: A Visual Introduction to Fed Tapering

 

MARKETS IN A MINUTE

Explainer: A Visual Introduction to Fed Tapering

Published 7 days ago 

on January 13, 2022

By Dorothy Neufeld

 

Explainer: A Visual Introduction to Fed Tapering

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The Federal Reserve began tapering its large-scale asset purchases in November 2021, a move likely influenced by:

• Rising inflation
• Improving unemployment
• Strong U.S. GDP growth

More than $4 trillion in capital was injected into the economy through quantitative easing (QE), over the course of the pandemic, inflation is at 40-year highs, and unemployment levels hover below 4%.

As Fed policy responds to a recovering U.S. economy, this Markets in a Minute chart from New York Life Investments shows how Fed tapering works, and its impact on the economy.

How Fed Tapering Works

Fed tapering is the unwinding of the Federal Reserve’s large-scale asset purchases.

After the 2008 financial crisis, large scale asset purchases were introduced for the first time to inject liquidity into the market and help restore confidence. During the pandemic, they were introduced once more, at a rate of $120 billion per month.

Here’s how it works:

1. The U.S. central bank buys government bonds typically in the form of Treasuries and mortgage-backed securities (MBS).
2. This influx of demand leads to a rise in these bond prices and their yields (interest rates) fall.
3. As this lowers the interest rate on the government bonds, what often follows is lower interest rates on loans for households and businesses.
4. Lower rates stimulate spending.
5. When the economy is running well, the bank may unwind asset purchases to help keep inflation low, otherwise known as Fed tapering.

Explainer: A Visual Introduction to Fed Tapering (visualcapitalist.com)

Explainer: A Visual Introduction to Fed Tapering