“Tapering is tightening” is a common saying on Wall Street describing the Federal Reserve’s anticipated reduction in its stimulus program and rising interest rates. In response to the Covid-19 pandemic, the Federal Reserve initiated several broad actions to limit the economic damage, including decreasing short-term interest rates to nearly zero and resuming a massive bond purchasing program, all designed to help restore confidence and market functionality. At the time of announcing the stimulus program – Spring of 2020 – the Fed conveyed to stakeholders these programs will remain in place until there is clear evidence the economy is on solid footing.
Today the economic picture is much different. Economic growth has rebounded, and corporate profits are coming in at record levels, while inflation and unemployment continue to complicate the matter. Fed officials have largely agreed there has been enough progress on inflation, while more improvement is needed in the labor market. All of this has led the Fed to acknowledge the economy has reached a point where it no longer needs to provide as much stimulus.
So long as economic progress continues, the Fed will likely begin “tapering” or reducing the amount of bonds it buys before the end of the year. The withdrawal of easy-money policy should be viewed as “tighter” monetary policy. However, tapering is much different than interest rate liftoff. The Fed works on two mandates, price stability and maximum employment, and before any interest rate announcements, the labor markets will need to experience significant improvements. Investors should be positioning portfolios to withstand tapering and the eventual interest rate liftoff from nearly zero.
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