- [Narrator] In this market environment,
the very mention of one economic term sets
the big indexes on edge.
- But at this point, the economy is very strong
and inflationary pressures are high.
And it is, therefore, appropriate in my view
to consider wrapping up the taper
of our asset purchases,
which we actually announced at the November meeting
perhaps a few months sooner.
- [Narrator] That's the Chairman of the Federal Reserve
in late November, foreshadowing that the central bank
would speed up tapering or winding down
of the bond-buying program it launched in 2020
to help fight the COVID-19 economic crisis.
His words sent a shudder through the markets.
- Taper. - Tapering.
- Tapering. - Taper.
- They should be tapering.
- [Narrator] And it's easy to see why.
The Fed's stimulus has fueled a historic rally
that has lifted major indexes
far beyond their pre-pandemic highs.
So if the economy is strong, as Powell said,
and stimulus has been so good for stock portfolios,
why are the markets so worried?
Here's Jerome Powell again.
This time in July of 2020,
amid pandemic shutdowns that had ground the global economy
to a halt.
- At the Federal Reserve, we remain committed
to using our tools to do what we can
and for as long as it takes
to provide some relief and stability.
- [Narrator] He was promising in part
to continue purchasing $80 billion of Treasury bonds
and $40 billion of mortgage-backed securities every month
to increase the money supply, encourage lending
and help bring the economy back from the brink.
This type of stimulus is called quantitative easing.
And it works like this.
When the Fed buys securities on the open market,
it takes them out of circulation,
leaving fewer for everyone else to complete for.
With less supply, investors bid up the price
of the remaining securities,
and is always the case with bonds,
when the price goes up, the yield goes down.
So what does it mean for you?
Since treasuries are a benchmark
for other types of lending,
lower yields on long-term Treasury bonds
can mean cheaper corporate bonds and mortgages,
which can lead to more hiring and home buying
throughout the economy.
This helps explain why markets thrive
on quantitative easing,
and why they get jittery at the mention of tapering.
But there are a few things to keep in mind.
First, tapering refers to winding down the rate
at which the Fed adds to its balance sheet,
not actually reducing the total holdings.
The current plan is to reduce purchases
by $30 billion a month to end in March.
During this period, the Fed's balance sheet
will keep growing, just more slowly.
Second, winding down then stimulus puts the Fed
in a position to focus on another
of its imperatives, price stability.
Here's the former secretary
of the Treasury Larry Summers talking
to The Wall Street Journal's Greg Ip.
- We're now running with inflation in the 5, 6% range.
And achieving the soft landing from that without recession.
I think it's not likely to be easy.
- [Narrator] Inflation rose to 6.8% in November
from a year earlier.
The fastest pace since 1982.
A year and a half of stimulus
has driven a rise in household income,
spurring a sharp run-up in home values
and other assets.
This has boosted wealth for many Americans,
fueling stronger demand.
Meanwhile, a tight labor market
and lasting supply chain issues
has restricted supply,
leading many businesses to raise prices.
This is the big reason Powell is talking
about speeding up the taper.
The sooner the Fed completes the wind-down,
the sooner it would be able to focus
on bringing inflation back down to its 2% target.
- We are committed to our price stability goal.
We will use our tools, both to support the economy
and a strong labor market,
and to prevent higher inflation
from becoming entrenched.
- [Narrator] On Wednesday, Fed officials signaled
they were prepared to raise interest rates next year
to help bring down high inflation,
and some more hawkish economists see a bumpy road ahead.
- I think we've got a very difficult set
of policy management challenges ahead of us
with a period of entrenched inflation looking
like the immediate prospect.
- [Narrator] But for all the Fed's preparations,
Powell says it still expects inflation
could retreat on its own.
- Most forecasters, including at the Fed,
continue to expect that inflation
will move down significantly over the next year
as supply and demand imbalances abate.
- [Narrator] With an uncertain road ahead,
the markets will continue watching the Fed
for any sudden moves.
(pensive music)