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Tapering – What does it mean and why does it matter?

View from the dealing floor.

by Chris Tripp, IG.

‘Tapering’ is a word being used more commonly by investors in recent times; it is dividing the opinions of economists and causing global volatility. But what does it actually mean? Why is everyone watching and waiting for signs of it? And if it does happen how will it impact the global financial markets?

Since September last year the US Federal Reserve has been buying a whopping $85 billion of securities on a monthly basis, compiled of $40 billion of mortgaged-backed securities and $45 billion of Treasury-backed securities. This cash injection’s primary objective is to help stimulate the economy by bringing down long-term interest rates– a process commonly known as quantitative easing (QE). However, it has been fulfilling a secondary role of late, supporting the performance of financial markets, with any mention of its scale-back having detrimental consequences on the very same markets it is supporting.

Tapering is a phrase which saw its way into investors’ vocabulary back in May this year, by the then head of the Federal Reserve Ben Bernanke.  He stated in his testimony to congress that the Fed could ‘step down their rate of purchase’, which sent shockwaves through the markets causing the Dow to drop over 100 points. Essentially, tapering is the winding down of this security purchasing policy as the economy recovers and thus, in theory, providing a seamless transition for the economy back to self-sufficiency. 

Fast forward to September this year and it was widely perceived by analysts that this tapering would make its debut, however Mr Bernanke shocked these analysts by deciding the economy was still too fragile for tapering. As a result the Dow Jones strengthened by over 700 points in an eight day period, breaking the 15,710 level.