By now you know that the Fed just started the dreaded “taper” but if you’re normal, you have no idea what that means. So let us explain.
During the Financial Crisis, the Fed was forced to cut rates to basically zero to get the economy going again.
But that wasn’t enough! Unemployment remains high.
So the Fed has used new unusual tools to stimulate the economy since it can’t cut rates below zero.
One of the big tools is quantitative easing, which is purchasing of government bonds and mortgage bonds, in an effort to further depress long-term interest rates and get liquidity into the market. This is how the Fed eases policy since it can’t cut rates.
The Fed has done a few rounds of Quantitative Easing since the crisis, but the latest has been open ended, meaning the Fed buys $US85 billion worth of assets every month. And the Fed has indicated that it would not stop tapering until the economy was strong.
We’ve gotten a nice kick of strong data lately (good jobs numbers, falling unemployment, solid housing and manufacturing data) and the Fed feels it can start to ease back on the pace of asset purchases.
They’re not ending Quantitative Easing, they’re just reducing it barely. From now on it will only purchase $US75 billion worth of assets. At some point in 2014 most likely it will end it totally. And at some point much after that, maybe in 2015 or 2016 the Fed will actually hike rates.
So what does this mean for you? Not much really. It won’t have much of an impact on mortgage rates at this point, because it was all expected. Also because the Fed plans to keep interest rates very low for a very long time. The stock market is rallying on the news because again, this was basically baked in.
The main thing is that the Fed has started the path towards getting back to normal policy, where it’s not buying a bunch of assets each month, and instead guiding policy by trying to adjust interest rates.