Fed Explains Tapering

The US Federal Reserve is currently supporting the economy through regular asset purchases; mainly of government bonds and mortgage-based securities. Each month, it pumps $85 billion into the US economy in a bid to improve liquidity and to keep long-term government and domestic mortgage borrowing costs low. Under normal circumstances, these rates would be set by market forces, but in the aftermath of the global financial crisis, the financial industry still finds itself in somewhat of a tailspin. Banks are reluctant to lend to business, hence the need to improve liquidity in the economy, and also need to improve their own balance sheets (by holding more cash) to be better placed to withstand a future banking shock.

It has always been clear that the Federal Reserve’s stimulus package could not continue forever without running the risks of a global loss of confidence in the US Dollar as the world’s reserve currency and hyper-inflation. Like a life-support system, if the patient is to have any quality of life, the support must eventually be withdrawn and the patient allowed to stand on his own two feet. Federal Reserve Chairman, Ben Bernanke, had commented that he believed the stimulus package would be “tapered” later this year and withdrawn completely at some stage next year. The remarks led to a collapse of investor confidence with stock markets around the world falling back on the gains that they had seen this year. The Dollar fell from 102 Yen down to a low of 94 Yen and has no recovered to stand at about the 98 Yen mark.

In order to calm the markets, the Federal Reserve has clarified its position on tapering and explained that it is to be inextricably linked to the health of the US economy. Members of the Federal Reserve’s Board of Governors have been clarifying the position: "if labour market conditions and the economy's growth momentum were to be less favourable, I would expect that the asset purchases would continue at a higher pace for longer," explained William Dudley, president of the Federal Reserve Bank of New York. Fellow Board of Governors member, Jerome Powell stressed: "The path of rates will ultimately depend on the path of the economy. I want to emphasise the importance of data over date."
However, despite these assurances, mortgage rates have risen by 1% over the last month and stand at 4.46% on a 30 year loan; this is their highest level in two years.