Tyndall: Tapering tantrums

Financial market participants are currently fretting over the “will they or won’t they?” question of whether the Federal Reserve will finally begin to reduce its level of asset purchases over the next few months – the so called ‘tapering policy’. 

Admittedly, some analysts are maintaining that even if the Federal Reserve does begin to reduce its level of bond purchases, this will not represent a tightening of monetary policy since the banks “will still have plenty of liquidity anyway” and such a move “will not affect short term interest rates” but we have little sympathy with this viewpoint, not least of all because when the bond purchases were originally announced they were treated as an easing. 

More importantly, we also find that virtually the entire current – and still reasonable – rate of monetary growth that has been occurring in the US which has presumably been supporting domestic asset prices so far this year has in fact emanated from the Federal Reserve’s continued bond purchases.  Indeed, we calculate that if the Fed halves its rate of bond acquisitions, then US liquidity growth will also probably halve – or worse. 

Unbeknown to many, the US commercial banking system has essentially been shrinking its credit books – and therefore destroying liquidity – so far this year as a result of the intense if rather technical regulatory tightening that took place in early January and this is of course why the Federal Reserve has become the only de facto source of liquidity growth within the economy.