Since the beginning of the COVID-19 pandemic, the Federal Reserve has pumped liquidity into the economy on a massive scale. It has purchased around $120 million worth of bonds every month and kept the interest rate at zero. While this has resulted in very favorable conditions for the average American and businesses alike, it’s coming to an end. Don’t fear their bond purchase taper plan. It’s time.
Fed policy kept the economy afloat
Nobody knew how extensive the economic damage from the pandemic would be, and nobody – especially not the Fed Governors – wanted to find out. In a master stroke, Fed Chair Jerome Powell and the Federal Open Market Committee stated they would whatever it took to keep the economy vibrant. They also said that their generous accommodation policy would continue until they were satisfied with the employment data. (The Fed has two mandates from Congress: full employment and price stability.)
Their generous policies could not continue forever. The Fed was essentially printing money when it was buying bonds. Eventually, this would have a negative effect on prices and the economy. That’s the challenge for the committee. When is the right time to halt purchases? The minutes from their most recent meeting reflect an agreement that it’s time to taper their bond purchases.
Don’t fear the Fed’s bond purchase taper plan
The markets are driven by liquidity, so it was inevitable that traders and investors would not take the Fed’s bond purchase taper plan lightly. Last Wednesday, we saw round one of a “taper tantrum.” The indices lost 1 – 1.2% one day after moving higher. With several Fed Governors talking the talk (loudly!) about the bond purchase taper plan, it will come as no surprise if the Fed announces during their next meeting (in September) when it will start.
Given the strength of the economy and the potential for a very strong jobs reports, it’s time for the Fed to get ahead of the curve and avoid causing damage to the economy.