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The much-awaited taper of the US Federal Reserve’s monthly bond purchases is finally here. In the November 2021 FOMC Meeting, Chairman Powell announced that monthly purchase of Treasury Securities will reduce by $10 billion and purchase of agency mortgage backed securities will reduce by $5 billion from November.
Stock market was unfazed by the announcement with the S&P 500 gaining about 1 per cent after the announcement and US treasury securities remaining stable. The reasons why markets are not too perturbed at this points is because the taper of bond purchases will not mean that the liquidity in the system will reduce immediately. In fact, liquidity will continue to increase until June 2022. Two, the Fed has prepped the market adequately about the coming taper with hints and indications. Three, markets are more concerned about hike in Fed funds and there is no signal from Fed about a rate hike yet.
The taper schedule
The Fed is currently purchasing $80 billion of treasury securities and $40 billion of mortgage backed securities every month. The quantum of these purchases will begin reducing from this month to the extent indicated above. With monthly reduction, fresh asset purchases will end by May 2022.
But it needs to be noted that the Fed balance sheet, that currently stands at $8.57 trillion will continue to grow in size until next May. It is expected to increase by $420 billion between November 2021 and May 2022. Even after the monthly bond purchases end, the Fed Chairman has stated that extinguishing of expiring bonds will not be done in a hurry, thus keeping liquidity elevated for as long as required.
It’s only when the Fed stops rolling over the existing bonds that Fed Balance Sheet will begin shrinking. The tightening of Fed balance sheet will however have to begin next year or by 2023 since the higher liquidity is partially responsible for driving CPI inflation in the US beyond 5 per cent.
Interest rate hike
Financial markets are however more concerned about the Fed Funds rate that is currently at multi-decade low, close to zero. Loans borrowed in US dollar is responsible for driving trading in stocks and commodities across the regions. Past data shows that equity markets begin a serious decline only when the Fed begins hiking rates.
Indian equity markets are also unlikely to react much to the Fed taper since stocks have been rising to record highs in October despite FPIs pulling out close to ₹13,550 crore. Purchases by domestic retail and institutional investors seems to be mitigating the impact of the FPI outflows quite efficiently.
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