US Federal Reserve bank and tapering: what does it mean?

US dollars

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Chairman of the Federal Reserve, Ben Bernanke, introduced ‘tapering’ during the conclusion of the two-day meeting when each arm of the Federal Reserve bank met this week. However, not many people understand the meaning or usage of the word in this instance, so here is a brief description.

During the financial crisis in mid-2008, the Federal Reserve, or the Fed, cut interest rates to nearly zero percent in an attempt to stimulate the economy; however, unemployment continued to remain high. So the question was: How does the Federal Reserve continue to stimulate the economy without cutting interest rates?

The answer was to pump money into the economy directly by using quantitative easing.

The Fed launched its third round of quantitative easing in late 2012, when it began purchasing long-term US Treasuries and Mortgage backed securities (government debt and mortgage bonds) in order to cut borrowing costs and force cash back into the system. Tapering is the process of slowing or lowering these purchases.

According to BBC Business news, this Wednesday the Fed announced that it was tapering, or scaling back, those purchases from $85 billion dollars a month down to $75 billion dollars a month.

Managing partner at Landcolt Capital, Todd Schoenberger, noted, ‘A ten Billion dollar change won’t be missed. It won’t impact the economy. A change this small is almost like it had done nothing at all.’

Further tapering is dependent upon how the economy responds. But why Now?

The decision to taper is an indicator that the Fed believes the United States economy is gaining strength. Recent data shows that economic growth increased its pace 3.6% in the third quarter, and unemployment fell to 7% percent, which is a five-year low.

The S&P 500 closed at a record-high this past Wednesday, largely due to the Federal Reserve’s decision.

Meanwhile, the Dow Jones rose 1.8 percent. Europe followed the United States’ lead and the CAC-40 in France closed 1.6 percent higher, and the FTSE 100 closed up a full 1.4%.

 

Keep up-to-date with what’s happening on the financial markets: http://www.ig.com/uk/market-news-and-analysis

 

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