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Health & Fitness

Taper Talk? Not so fast

Tapering, or taper talk, has dominated the financial media conversation during the last few months, and that is for good reason. The object of the eventual tapering is the Quantitative Easing (QE) program that has been one of the central programs utilized by the Federal Reserve to try to help the U.S. economy recover for the financial crisis of 2007-2008. The original QE, and the iterations that have come after, have all been based on the same principle, that the Federal Reserve can “prime the pump” for an economic recovery by injecting liquidity into the system, and that this will encourage institutions to lend, consumers to borrow, and businesses to expand. Like all carefully-laid plans, however, things have not worked out exactly as planned.

Unemployment is down to 7.3% on a national level, inflation is running at a moderate 2.1%, but is the underlying strength the true driving force behind taper talk? The Federal Reserve itself had set benchmarks of 6.5% and inflation running at 2.5% as its own guidelines for when it would begin the tapering process. This leads me, and many others, to believe that there are different underlying forces behind the tapering process.

As we have covered here, emerging market economies and their currencies have been impacted rather severely by the possibility of Fed tapering and rising rates in the U.S. Fueled by inflows in search of higher yields, these markets and currencies are now feeling the reverse, as money has begun to return to the U.S. in the face of rates that have inched up. In addition to the possible overheating of emerging markets due to “hot money” inflows, which has driven up inflation overseas, there is also the focus on the Fed itself. The Fed’s balance sheet has grown to $3.7 trillion dollars since the financial crisis, and many market watchers (including yours truly) have begun to seriously question whether or not the Fed exercises too much influence on the equity markets, and the very real possibility of more asset bubble creation.

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In spite of all of these events connected to the ongoing tapering, the Fed has decided not to begin tapering, which triggered a spike in the equity markets, but a much more subdued reaction in the bond markets, with yields remaining relatively flat. The primary reasoning behind the Fed’s decision not to slow the pace of QE is that, while the U.S. economy has begun to improve, the rate of improvement has not yet reached “escape velocity,” i.e., become self-sustaining. Precious metals reacted with an upward movement after this announcement, as the continued printing of U.S. dollars might lead more investors to put money to work in hard assets such as previous metals as a hedge.

Winners from the “taper dud” might include emerging markets that will face less competition in the face of lower U.S. rates due to continuing Fed buying, precious metals, commodities, real estate, and other “hard” assets as investors seek protection against inflation. Additionally, dividend stocks may stage a recovery as investors cycle back to them if interest rates are held lower in the near term. Of course, there is always the possibility that the market will begin to doubt the Fed’s sincerity/appetite for tapering and begin pushing yields up regardless of today’s announcement.

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