The markets were down last week despite solid gains on Friday. Unemployment claims are at the lowest since the pandemic began, so what was the problem? Minutes from the Federal Reserve Bank, or the Fed, were released last week and those notes caused a small taper tantrum.
And what is that? Some background first: the Fed is our central bank, tasked with maintaining price stability and full employment. Put simply, keeping inflation low – defined as around 2% -- and unemployment at or below 4%. They have several tools to do this. Historically, the primary method is by setting the prime rate, which drives interest rates on everything else: credit cards, Treasury bonds, loans, and other debt products.
An additional tool is Quantitative Easing, the purchase of bonds and other securities, which the Fed uses when interest rates are near zero, and lowering rates further is not the best option. The Fed is currently buying about $80 billion a month in Treasury securities, and $40 billion a month in Mortgage-Backed Securities. It keeps bond interest rates low, driving investors into stocks in search of higher returns. Low rates also make it easier for companies to expand, and consumers to buy houses and cars, all of which drives the economy.
As the economy continues to grow and recover from the pandemic, members of the Fed are indicating a willingness to taper, or reduce, these bond purchases. They are not stopping the purchase altogether, and they aren’t beginning to sell the ones they hold. Just reduce the amount they are purchasing monthly. Markets reacted by falling sharply early in the week.
Friday’s gains show investors are still willing to buy the dip, or invest when stock prices fall. Many economists believe that the Fed will hold off on tapering until they have more certainty around the impact of the Covid Delta variant. Either way, we should have more data after the Fed’s annual meeting this week in Jackson Hole.
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