Fed tapering

It is clear that the Fed will begin scaling back its stimulus drive. This is crucial given that the current stimuli wave extended well beyond the post-2008 monetary and fiscal expansion.

If tapering is swift and harsh, its impact will be tough. The last time the Fed scaled back stimulus, in May 2013, even discussions of stimulus cuts created volatility in global financial markets.

July minutes reveal that some governors believe it would be good to postpone tapering until Q1 2022. Most investment houses, however, pen in an almost immediate shock, though some also claim the impact has already been priced in.

Whether tapering begins soon or not, it isn’t the same thing as a rate hike. A rate hike is quite a jumpstart because the Fed ordinarily acts sequentially, i.e. many hikes or cuts in a row once the direction is determined.

True, the Fed’s balance sheet has reached USD 7.7 trillion as compared to the previous peak of USD 4.4. However, there is also a shift in composition, and the Fed is currently holding 69% securities as opposed to 59% in the post-Lehman episode.

This means MBS holdings are down to 31% from 42%. This implies that asset holdings carry shorter maturities because MBS holdings have very long maturity by definition, i.e. up to 40 years.

Again a shorter maturity, i.e. c. 7.5 years as opposed to c. 10 years in the past, implies a much lower reduction in the BS. Accordingly, even if tapering begins in 2021, in equilibrium the FED BS will stand above USD 8 trillion in 2023, possibly at USD 8.5 trillion or more.

Therefore, because maturities are shorter, tapering will take a longer period of time, and will certainly be more gradual than the 2013 tapering. Accordingly, if only due to the rise of the Delta variant and its negative economic consequences, initiating a rate hike sequence will also take time.

If Treasury purchases are cut by USD 10 billion per month and MBS purchases by USD 5 billion per month, ‘tapering’ should take approximately three quarters, potentially less. But if tapering begins in Q1 2022, it will take the entire year, and rate hikes will be postponed to 2023. Very predictable, indeed.

If you don’t misalign, you probably do not have too much to be afraid of this time around. The Fed, knowingly or not, gives time and opportunity to all EM central banks (and even to China) so that they can adjust gradually before the tapering storm.

Guzel Sanatlar Printing House printed this stamp in 1965 to celebrate the 40th anniversary of the Turkish Aeronautical Association.