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What Does Tapering Mean for U.S., Global Economies?
Stock Analysis & Ideas

What Does Tapering Mean for U.S., Global Economies?

It’s official. Tapering, the gradual rolling back of the Fed’s bond-buying program, is set to begin in mid-November or mid-December, and be completed by the mid of the following year.

That’s according to the FOMC minutes released on Wednesday.

How will that affect U.S. Treasury bond yields, and the U.S. economy? There are two plausible scenarios. (See Insiders’ Hot Stocks on TipRanks)

Scenario 1

The first scenario is that tapering will reduce the demand for U.S. Treasury bonds, and push yields higher. Thus, it will further signal the end of accommodative policy. 

Since 2020, the Federal Reserve has been buying $80 billion of U.S. Treasury securities and $40 billion of mortgage-backed securities (MBS) monthly. The Fed plans to gradually reduce these purchases every month, and eventually eliminate them by the mid of next year.

Unless the U.S. Treasury Department cuts down the issuing of new bonds at the same pace, or a big buyer (e.g., China) steps in and buys U.S. Treasury bonds, bond yields will rise.

There’s a precedent for this scenario. A similar policy pursued in the summer of 2013 was followed by what has become known as taper tantrum, a spike in the 10-year U.S. Treasury bond yields from 1.94% to 2.96%.

While the impact of rising bond yields was mild for the U.S. economy, it was devastating for the emerging market economies. They prompted a massive capital outflow from emerging markets to the U.S., causing a sharp dollar appreciation against emerging market currencies.

A stronger dollar, in turn, threw emerging market economies with a large dollar-denominated debt, like Turkey, into crisis.

Scenario 2

There’s a second scenario. Tapering will push bond yields lower, as it will help tame inflationary expectations, the primary driver of long-term yields.

Lower yields will fuel capital outflow from the U.S. to emerging markets, devalue the U.S. dollar, and boost U.S. exports and economic growth.

Meanwhile, it will save emerging market economies with a sizeable dollar-denominated debt of another crisis.

While opposite, the two scenarios aren’t mutually exclusive. The Federal Reserve has prepared financial markets well for tapering this time around.

It began a series of pre-announcements six months ago, now has an official timetable for doing it. That gave the markets plenty of time to discount the first scenario, and push Treasury bond yields higher in anticipation of lower Fed demand for Treasury securities.

Now, they are getting ready for the second scenario, the taming of inflationary expectations.

Thus, the decline in bond yields following the September FOMC minutes on Wednesday spells out the Fed’s tapering plan.

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