Markets & Economy
What's next for quantitative easing?
December 18, 2013
Rebecca Katz: Our next question is from Scott in Richlands, Virginia, and Scott says, "In your opinion, what might be the best way for the FOMC to handle the difficult task of scaling back the stimulus in a way that won't severely impact the long end of the curve, sending rates higher and higher and crushing this ever-so-delicate recovery?"
Joe Davis: Sure. It's clearly a question, a very important question. It's not only on the minds of our clients and investors, of ourselves, but also, importantly, the Federal Reserve themselves. So I think what we will very clearly see is they very likely begin their tapering program, which again means just adding less at a lesser rate to their balance sheet. That they will pair that with what some investors may hear, and the press is calling, "forward guidance," which means the threshold and the timing with which the Federal Reserve will begin to raise short-term interest rates.
And so a general expectation of the market is the middle of 2015, which is a long time before we may see short-term rates rise, and so I think, if anything, they may provide greater criteria with respect to the level of unemployment as well as the rate of inflation—both of which are off of where they would like them to be—to fine-tune that sort of message.
And so, if they do that, at the end of the day, long-term interest rates to the 10-year Treasury yield is ultimately a reflection of what the expected short-rate or cash-rate or money market rate would be over the next 10 years, plus or minus a risk premium.
So if they can convince the market that they will be on hold for an extended period of time, all else equal, you can at least hope that those interest rates may not rise dramatically. I think in that sense, they will be—that there's a decent probability that they will be successful on that front.
Rebecca Katz: Our next question is from Steve in Columbus, Ohio, and he asks, "How much of the anticipated reduction in the Fed's purchasing of mortgage bonds has already been priced into the markets."
Joe Davis: I think it's fair to say that most has been, both with respect to mortgage security purchases as well as Treasury purchases. I mean in the aggregate, they're purchasing $85 billion per month. The key question is, "What will be the details of the tapering, and what sort of mix may they do?" I think the consensus scenario is that there may be a split between the two and they will reduce the pace of purchases, perhaps $5 or $10 billion per month over the course of 2014.
But again, this is where, in some respects, the Federal Reserve may adjust policy with respect to how strong or weak data may be coming in, as well as how volatile the financial markets become. This is going to be a fluid exercise. I think ultimately at the end of the day, though, they will try to keep to the plan to provide some clarity to the financial markets.
Rebecca Katz: It's interesting because that isn't really the provision of the Fed. They're making decisions—aren't they supposed to make decisions outside of whether or not it has an impact on the financial markets, or is that not actually how it happens?
Joe Davis: Well, it's a really—it's an important question, Rebecca. My opinion is that any policymaker may have to look past short-term volatility—I'm not saying the Federal Reserve has not done so—because you have to take into account the future performance of the economy and the financial-market conditions to make policy in real time. Where, however, it can get complicated is if there's a very marked strong reaction to the financial markets that then can alter what one expects for economic growth or inflation going forward.
So unless it is a very large upward or downward change to the financial markets, I think broadly speaking, policy will continue on some sort of clear path.
Joe Davis: Here we are, and the likelihood is that the Federal Reserve will begin their tapering program, if not by the end of this year, they perhaps will announce in the early part of next year. Trying to nail down the actual date really depends on the economic data as it comes in. But it is likely, and I think it could be reasonable to expect some financial market gyrations, in large part because the stimulus and aggressiveness of monetary policy, not only just the United States, but globally has been so profound and in many ways unprecedented in both size and scope, that I think that it's natural to have some sort of modest rise in risk-aversion if it appears that they're beginning to remove that.
Now, that said, we as long-term investors—if I have a choice between no tapering at all, or beginning a tapering program under the assumption, or under the expectation, that the economy does not need as much emergency stimulus as it did, I would clearly take that option.
Rebecca Katz: Because that's a sign that things are getting better.
Joe Davis: It's a sign, so again, we are clearly of the mind at Vanguard that this is ultimately good news for investors, but there may be some market dislocations for a period of time. But a more dire future is one where the economy does not gain any traction—and we're talking three years from now, Rebecca—of when is quantitative easing beginning to taper? So I think this is good news.
All investments are subject to risk, including the possible loss of the money you invest.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved.
The markets weigh news of Fed tapering
On Wednesday, December 18, Federal Reserve Chairman Ben Bernanke announced plans to begin scaling back the Fed's "quantitative easing" (QE) program of asset purchases. In this video recorded on December 5, Vanguard chief economist Joe Davis explains why the end of QE could reflect good news for the economy, even if it causes some short-term market volatility.
Other excerpts from this webcast:
- All investing is subject to risk, including the possible loss of the money you invest.
- This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.