What You Need To Know About Tightening U.S. Monetary Policy

tapering its bond purchases

Governments around the world launched aid programs to contain the economic consequences of the COVID-19 pandemic. This is largely through multibillion-dollar bond purchases designed to provide the economy with liquidity. 

While the European Central Bank has planned to reduce its bond purchases only slightly, its colleagues at the U.S. Federal Reserve are planning more drastic steps. This could lead to turbulence in the markets. As an investor, you should know the details and take timely action to protect your assets.

$15 Billion Less Fresh Money Per Month

The Fed currently buys $120 billion worth of government bonds and mortgage-backed securities every month, but that is expected to end soon. The Federal Open Market Committee of the U.S. central bank announced after a two-day meeting that the Fed wants to curb the amount of purchases of U.S. government securities by $10 billion per month. It also wants to curb its purchases of mortgage securities by $5 billion per month. 

The reduction in purchases is to start as early as this month, so that the program would end completely in June 2022. If the Fed makes further reductions to its purchases over the next few months, the wind-down could move even faster. 

With the reduction of bond purchases, the U.S. Federal Reserve is heralding a normalization of monetary policy. This is necessary because the purchases have caused the Fed’s balance sheet to rise to a record $8.5 trillion. 

Back in the summer, Fed Chairman Jerome Powell had signaled that he would scale back the measures adopted during the pandemic as soon as the economy recovered from its aftermath. This is now the case; the U.S. expects growth of over 6% this year.

The markets have now become accustomed to the reliable supply of fresh money from central banks and could collapse completely if that money tap were turned off overnight. That’s why the U.S. Federal Reserve wants to proceed cautiously and exit step by step.

What About Raising Interest Rates?

Curbing bond purchases is a first step toward monetary policy normalization, which could soon be followed by a second: raising the benchmark interest rate. It’s probably only a matter of time before Powell raises the prospect of interest rate hikes. 

However, it may still take some time before this happens. Deutsche Bank in the U.S. expects the Fed to announce its first interest rate step-up in December 2022. Economists and other financial institutions are more cautious and do not forecast this until early 2023.

ECB chief Christine Lagarde has described a rate hike in the eurozone next year as very unlikely, but what is certain today? If the U.S. announces a rate hike and inflation continues to rise in Europe, the ECB could also be forced to think about a possible rate hike.

Turbulence on the Stock Market

Overall, uncertainty is high – and uncertainty is always poison for the stock market. For this reason, things could soon go awry. The post-pandemic-selloff bull market could slowly come to an end – and you should be prepared for that. 

There is still time to protect your assets, but time is running out. Therefore, do not wait too long and take action now to avoid high losses or even total loss.

Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.
Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.

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