Editorial: Lighting the taper

Five years after the launch of quantitative easing, the US Federal Reserve has begun to unwind. On

the day of Ben Bernanke’s last press conference as chairman, the Federal Open Market Committee has

decided that it will finally scale down its $85bn-a-month asset purchases programme. The US

monetary authorities will now buy $10bn fewer Treasuries and mortgage-backed securities each

month.

The very idea of “tapering” has the ability to inspire awe in markets. But the direct impact of the Fed’

s actions should be negligible. The central bank will still be pumping money into the economy, if only a

little more slowly. Even the change of pace must be put into perspective. By the central bank’s own

back-of-an-envelope calculations, $200bn in purchases are equivalent to 25 basis points of the policy

rate. A $10bn reduction is therefore worth a 20th of that. Under normal circumstances, investors

would barely notice.

But these are not ordinary times. Wednesday’s decision means that the largest and most

unprecedented monetary experiment in the Fed’s history is beginning to come to an end. When the

Fed contemplated withdrawing its stimulus last May, both mortgage rates and US government bond

yields shot up. Assets and currencies in emerging markets plummeted, too, as investors fled for safer

havens. The fear is that the actual decision will lead to a new wave of market turmoil.

Volatility will inexorably increase. The yield on the US 10-year note climbed as high as 2.92 per cent

on the announcement. But unlike the situation six months ago, the Fed has taken some careful steps

to explain that tapering is not the prelude to higher interest rates. It has for instance changed its

“forward guidance”. Until Wednesday, the Fed had promised not to raise rates until unemployment

had fallen below 6.5 per cent. Now it is undertaking to keep rates low until “well past” this threshold.

The Fed cannot of course control market rates. But even if these were to rise, the US economy is in

a much stronger position than it was to withstand the shock. National income expanded at an

annualised rate of 3.6 per cent in the three months to September. Both retail sales and industrial

production grew rapidly in November, a sign that the recovery should remain robust in the fourth

quarter. Looking ahead into 2014, a deal on the US budget has reduced the size of the fiscal drag.

While inflation remains well below the Fed’s 2 per cent target, it should finally pick up as the uplift

gathers pace.

Tapering has consequences for the world beyond the US and these are less predictable. In particular,

developing countries still look vulnerable. True, many retail investors have already fled emerging

markets following this summer’s “taper talk”. As a result, asset values are less frothy. Some central

banks – for example the Reserve Bank of India – have also successfully supported their currencies by

tightening liquidity. But investors are bound to be more scrupulous about where they choose to park

their money. Frailties such as large current account deficits will be exposed.

The biggest challenge is perhaps for Janet Yellen, who succeeds Mr Bernanke when he leaves the

Fed at the end of January. As Mr Bernanke’s deputy chair, Ms Yellen clearly had a major hand in

Wednesday’s decisions. Yet, when she takes the top job, investors will keep a close watch to see if

her views diverge at all from those of her predecessors.

As the head of the Fed’s subcommittee on communication, Ms Yellen is well trained for this task. But

she will need to prove her mettle quickly. So far, quantitative easing has helped the US weather the

recession better than most other rich economies. But if the exit is not orderly, this will count for little.