Here’s what will happen when the Fed’s ‘tapering’ starts, and why you

On Sep 24, 2021

The Marriner S. Eccles Federal Reserve building in Washington.

Stefani Reynolds/Bloomberg via Getty Images

The Federal Reserve will likely start to tiptoe into the unknown before the end of the year.

Central bank officials indicated Wednesday that they’re ready to begin “tapering” — the process of slowly pulling back the stimulus they’ve provided during the pandemic.

While the Fed has gone into policy retreat before, it has never had to pull back from such a dramatically accommodative position. For most of the past year and a half, it has been buying at least $120 billion of bonds each month, providing unprecedented support to financial markets and the economy that it now will start to walk back.

The bond purchases have added more than $4 trillion to the Fed’s balance sheet, which now stands at $8.5 trillion, about $7 trillion of which is the assets bought up through the Fed’s quantitative easing programs, according to the central bank’s data. The purchases have helped keep interest rates low, provided support to markets that malfunctioned badly at the start of the pandemic crisis, and coincided with a powerful run for the stock market.

In light of the role the program has played, Fed Chairman Jerome Powell assured the public Wednesday that “policy will remain accommodative until we have reached” the central bank’s goals on employment and inflation.

Markets thus far have taken the news well, but the real test is ahead. Tapering represents a teeing up of future rate hikes, though they appear to be at least a year in the distance.

“It’s certainly been communicated well, so I don’t think that should be a shock to anybody or cause a disruption to the market,” Charles Schwab head of fixed income Kathy Jones said. “The question really is more around asset prices than [interest] rates. We have very high valuations across the board in asset prices. What does this shift away from very easy money do to asset prices?”

The answer so far has been … nothing. The market rallied Wednesday afternoon despite what amounted to a preannouncement for Fed tapering, and roared higher again Thursday.

How things go the rest of the way likely depends on how the Fed stage manages its exit from its money-printing operations.

How it works

Here’s what tapering could look like:

Powell said the official tapering decision could happen at the November meeting, and the process would commence shortly thereafter. He added that he sees tapering being finished “sometime around the middle of next year.” That timeline, then, offers a view into how the actual reductions will go down.

If the taper indeed begins in December, reducing the purchases by $15 billion a month would get the process down to zero in eight months, or July.

Jones said she would expect the Fed to cut Treasurys by $10 billion a month and mortgage-backed securities by $5 billion. There have been some calls from within the Fed to be more aggressive with mortgages considering the inflated state of housing prices, but that seems…