|The Fed is holding true to what they have been promising all year… a taper! DUN DUN DUN
2020 wreaked havoc across the global economy. To avoid economic collapse, the Fed gave a shot of adrenaline in the form of cash into the chest of the United States… a lot of cash. Fast forward to the end of 2021 and it’s time for the economy to fly on its own. So, the Fed is starting to pull back the amount of money it was spending to keep the economy afloat.
The Fed must be very careful with how they do this because giving money is easy but taking it away is really hard. The last time we saw this was post-2008. By 2013 the market was starting to stand on its own. So, the Fed announced that they would decrease QE spending at some time in the future. It’s important to know that they didn’t decrease spending… just said they planned to at some point. This caused absolute pandemonium in the T-Bill and MBS markets. Mortgage-Backed securities plummeted and mortgage rates did the opposite. This sent a shock wave of fear through the market and investors pulled their money out.
The Fed has committed to a $15B monthly taper in Nov and Dec ($5B of which will be coming from mortgage bonds). If they hold that pace through the beginning of next year, they would be done with the taper by the middle of the summer. Now, there are two reasons that the Fed only committed to the 2 months. The first is because they know they will have to increase the amount next year and are delaying the negative responses from the market. The second and more likely is because they are running these two months as a test and need to be able to hit the brakes if the market begins to fall as we saw in 2013.
This all sounds scary but the piece that most are not talking about is the Fed’s reinvestment. The Fed holds both bonds and treasuries and gets paid on them every month. Typically, the Fed would start applying those payments to its balance sheet debts and chipping away at that massive $8.5T. However, the Fed has decided they are going to keep their balance sheet ‘net neutral’ and reinvest the payments they are receiving from the securities they hold back into the bond market. So, even though they are tapering, they are doing a lot to prevent a taper tantrum.