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Is taper a big worry for the markets?

Team Veye | 30 Aug 2021

Is taper a big worry for the markets?

When the economy appears to be in a downturn, like in 2008-2009, or more recently, as it did at the start of the pandemic, the banks stop giving loans as they fear that their loans might turn into NPAs. At such times, the central banks step in and reduce interest rates and buy bonds to induce liquidity into the economy.

The net result of the action thereof is the increase of money supply in the economy by swapping out bonds in exchange for cash. The main objective of this policy is to keep the level of aggregate demand as high as possible in the face of the pandemic. The cheap money policy, of low rates and asset purchases, is to give support to asset markets and to help people and businesses afford goods and services.

The US Fed is currently buying bonds worth $120 billion since March 18, 2020. As of this date, the Fed had assets worth $4.7 trillion which has since increased to $7.8 trillion as of April 14, 2021.

US Federal Reserve Chair Jerome Powell on the 27th instant said the central bank could begin reducing its monthly bond purchases this year, though the initial hints from the Fed were about a tapering by 2024, which was quickly changed to 2023 and then to 2022. And now, it could finally happen by late 2021.

Tapering is the gradual slowing of the pace of the Fed's large scale asset purchases. It is a plan to trim bond purchases over an extended period. The hope is to wean the economy slowly off the extra stimulus the purchases provide to avoid a crash landing.

Earlier, when the July FOMC minutes made it clear that the tapering of monthly bond purchases was just months away, financial markets had reacted negatively, immediately after the release. But recovered smartly since then.

Markets will be watching not only when the Fed begins to taper, but the pace

at which it does so. Because in the wake of delta variant posing a new risk, while pulling back fast could derail the economic recovery, moving too slowly could increase the inflation pressures after the reopening from the pandemic.

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