What is tapering and why are equity investors unhappy with this Fed move?
Equity investors are not happy with tapering, but Fed has announced bond purchase programme could end in March instead of the original plan of June.
On Wednesday, the chair of US Fed Jerome Powell announced they are planning to do tapering in 2022. In his announcement, he has mentioned that "Fed will be buying US$ 60 billion of bonds each month starting in January, US$30 billion less than it had been buying in December. The Fed will speed up a reduction in bond purchases to US$30 billion a month so that the programme could end in March instead of the original plan of June”. This reduction in a bond purchase is called tapering.
This terminology ‘tapering’ sounds intimidating even for a finance person like me. But it is not that hard to understand.
From downturn to revival Economy
Last year the economy got affected severely by covid. We were in a recessionary phase where unemployment rates increased, the supply chain was disrupted, spending was reduced. To revive the economy Fed decided to put the money in the hands of people so that purchasing power will increase, which will eventually boost demand and the economy. This act is called quantitative easing.
From July 2020, Fed started buying bonds worth US$120 billion every month. We have seen the effect of it in last year stock market rally which had gained like never before. But right now Fed is concerned about the money supply programme which they want to reduce gradually and stop by March 2022. This act is called Tapering.
The problem with excess money supply is inflation. It has increased to a four-decade high to 6.8 per cent on November 2021, the highest since 1982. Fed is looking to increase the interest rates thrice in the upcoming year which will reduce the inflation heat. They are expecting inflation of 5.3 per cent for 2021 and 2.6 per cent for 2022.
There is an inverse correlation between increasing interest rates and the stock market. In theory, it is believed since the yields are higher money would move from the equity to bond market which will slow down the movement of stock prices.
Technically, after tapering and rate hikes money supply would be reduced, which will reduce the purchasing power and bring inflation under control. The market has not reacted much to the news on the announement day and the day after that but the effect happened today. Global indicies got hit badly, while Nifty ended 1.53 per cent down for the day.