Unless you have been off planet lately, perhaps just returning from a trip to Mars, you have heard lots of talk about “tapering” and you have probably noticed the impact all of that talk has had on the stock market. What does it all mean and how will it impact your retirement plan? Before we get to the last question, first we have to establish the back drop, understand the environment we are discussing.
Following the 2008 financial crisis, the Federal Reserve implemented a rarely used practice referred to as Quantitative Easing (QE) in an effort to stimulate an economy that was limping along. This practice involves the Fed buying up assets mortgage-backed securities and long-term Treasuries from commercial banks and other institutions. This activity has the effect of pumping money into the economy and reduces long-term rates. The theory is, when long-term interest rates go down, investors have more incentive to spend money, thereby stimulating the economy. The Fed is currently on the third round of QE – generally referred to as QE3 – whereby they are buying $30 billion in mortgage-backed securities and $35 billion in long-term Treasuries each month until sustained improvement is observed in the labor market. This is where we get to tapering.
Obviously the Fed cannot pump money into the economy indefinitely; it has to end the practice at some point. However, the feeling is that removing the stimulus all at once, going cold turkey so to speak, would have undesired impacts; hence tapering, removing the stimulus slowly.
The experts generally agree that tapering will have three effects. First, mortgage rates are expected to rise. In fact, we are already seeing an impact to mortgage rates. The second impact will be on the economy as a whole. The fear is that if the tapering of QE3 takes place too quickly, the economic recovery will stall. Third, when the Fed finally does start to taper, it is likely that stock markets will react negatively, at least in the short-term.
However, SavvyInvestors should recognize that in many ways tapering is a good thing. It indicates that the Fed believes the economy is strong enough to stand on its own, which means good news for the stock market, and investments, in the long-term. Whatever happens over the next few months, the Savvy move is not to overreact; relax, size up the environment, and make decisions that support your long-term objectives.
What say you SavvyReader? Do you believe the Fed will continue to taper and scale back QE to $55 billion at its 18-19 March policy meeting?