QE, Tapering & You, Oh My!

Quantitative Easing IIUnless 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.

Tapir

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? 

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

12 Comments

  1. Since it is the Fed’s intention to taper gradually, initially, this move will create some erratic behavior in markets. Long term investors usually will just sit back and ride the wave. Mortgage rates will increase which may affect the housing market, however, that should also settle at some point. If rates increase, then possibly there may be an increase in savings rates which will help many people who don’t invest, but only save.

    • Thanks for stopping in, Rosemary. Your insight into the housing market is greatly appreciated. It is not normally an area of finance that I watch closely. As more of a buy-and-hold investor, I don’t plan on doing much when the Fed starts tapering. In fact, if I have a little extra money I will buy on the expected dip.

      Have you seen the CNBC documentary House of Cards which takes a look at the origins of the 2008 financial crisis with an emphasis on the housing market; specifically Mortgage Backed Securities (MBS) and Collateralized Debt Obligations (CDO)? Check it out if not (http://video.cnbc.com/gallery/?video=1145392808#). Interesting stuff. You obviously are very astute with regards to mortgages and the real estate industry. I would love to get your take. Take care, my friend and I hope to see you here often.

  2. First, I have to say it is very sad that I have legitimate to think to myself, “Do opposite the govt. and you’ll probably be making the best decision”.
    Second, for the Fed to decide that they should ” buy up assets mortgage-backed securities and long-term Treasuries from commercial banks and other institutions” in order to stimulate the economy, just doesn’t make sense to me. That’s like paying off your teenager’s I’ll-gotten debt in an effort to help stimulate better decision making skills. Yeah, the debt is gone, which provides some economic elbow room. But, the teen doesn’t learn the skill of “dealing with the consequences of his/her actions”-aka personal responsibility.
    This leads to the same mistake(s) being repeated in the not-too-distant-future.
    So now we’re faced with the Fed slowly taking away this financial safety net which should not have been offered in the first place.
    Will tapering hurt the economy? Yes, but the real pain isn’t due to a lack of funds. It’s due to a lack of financial responsibility!

    • Because there are a number of factors (e.g. actions of government agencies) outside of their control, people need to be actively engaged in charting the course for their financial lives. As I advocate on this blog and in my book, Savvy individuals not only take the time to educate themselves on personal finance concepts, but they also take the time to develop multiple streams of income – with the expectation that one on more will be impacted by forces outside of their control – and develop multiple skill sets/pursue multiple education disciplines (e.g. dual majors), with the expectation that something out of their control could impact the career field in which they currently operate.

  3. Someday this will all make sense to me, but for right now I’m glad that I have decided to wait before buying a new home. Your advice to not overreact and to wait it out (higher mortgage rates, etc…) is very savvy! Thanks, James.

    • Sometimes the hardest thing to do is nothing. The key is to develop a long-term plan and manage it, understanding that there will be good periods and bad periods. Great to see you here, Kirsten, and I hope you become a regular visitor.

  4. I agree that overreacting is not necessary, but taking a profit
    and putting some cash on the sidelines may be wise while things
    are this volatile.

    • Thanks for stopping by, Brad. Then the question becomes how long to stay on the sidelines? Timing the market is a tricky business and not something I recommend for most investors. It is something I have done on occasion with mixed results. One of the contributors to my site, SavvyGage, insists that the right way to go is to be fully invested at all times. Believe me, attaching ‘Savvy’ to his name is accurate because he knows what he’s doing and has found great success, fully preparing himself and his family for a comfortable retirement. Good luck in the Amazon gift card giveaway!

  5. With so many factors involved, it is a “adjust as you go” move on the FEDS. Hopefully, the reaction won’t be negative and the economy will be able to sustain itself during the phases. It’s kind of like pulling someone slowly off of life support and hoping the organs support the person. We definitely don’t want to flatline!

    • Herman, Great analogy! Though it is likely to be bumpy at first, I believe the economy is probably strong enough to handle tapering…we will see. Just a reminder that you are eligible for the current Amazon.com $50 gift card giveaway and the $25 monthly giveaway (commencing next month) as a subscriber. Great to hear from you and welcome you to my blog. Good luck in the Amazon gift card giveaway!

  6. I agree with the time to come one must not react or take haste decisions, as you very well said long term investment is the best for stock market, no need to overreact at the short negative bears

    • No doubt that there will be a reaction, probably negative, when the Fed starts tapering. However, if you have a long-term plan in place, there is absolutely no need to overreact.

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