What is the Taper and Why Does it Matter to the US Dollar?
By John Kicklighter, Chief Currency Strategist and Gregory Marks
‘Taper’ fears are an issue that traders think about
every single day having recently spooked world markets while stirring
extreme volatility in FX, equities and bonds. ‘Tapering’ refers to the
timeline for the Fed’s eventual reduction in its massive, stimulus
program. The current iteration of Federal Reserve quantitative easing
(QE3) accounts for purchases amounting to $85 billion in Treasuries and
Mortgage Backed Securities (MBS) per month. The aim of this dedicated
buying is to lower interest rates and thereby bolster growth – however
investors have grown just as dependent on the unintentional side
effects: rising capital markets.
Taper(noun):
point at which the Federal Reserve reduces its $85 Billion monthly
purchases of Treasuries and MBS. Considered a crucial first step before
the support ends and is eventually reversed
Having ushered capital markets in the US to a
four-year recovery, investors are closely monitoring the time frame for
when the external support will be withdrawn. Though a tapering would
still mean further support – just on a modestly smaller scale –
speculators are conscious of the heights that the markets have been push
to and the assumptions made about the future with a backstop in place.
Reflecting on the sensitivity to speculation, last
week a simple statement by Fed Chairman Ben Bernanke that the Fed may
taper QE “in the next few meetings” resulted in extreme volatility and a
sharp drop for the S&P 500 as well as US Treasuries. And this is
not a lone voter. In the minutes from the central bank’s last meeting,
it was clear that the need to taper was seen by most while ‘some’ on the
board were even calling for a near-term moderation.
For the US dollar, there are two elements that
should be considered when it comes to speculation surrounding the taper.
On the one hand, stimulus growth directly increases the supply of
dollars in the system (increases inflation) and thereby its end removes a
burden from the currency’s shoulder. Perhaps far more influential,
however, is the impact that such a shift can have on risk appetite. If
optimism has founded a significant share of its strength on the belief
of indefinite support by the Federal Reserve, a reversion to traditional
valuations (growth, rates of return, liquidity, etc) could find the
markets abandoning richly priced assets.
--- Written by: John Kicklighter, Chief Strategist for DailyFX.com
Written by: Gregory Marks
Source: DailyFx
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