FED to Taper by Year-End

Updated: Sep 1

In terms of real GDP, the US economy grew by 6.6% in 2Q21. Real output has surpassed the previous peak in 4Q2019. The US economy would have probably grown even faster if there wasn’t an inventory shortage and companies could find employees willing to work. Both issues may become tailwinds for future growth once companies start building more inventory and once unemployment checks cease and people begin to work.

Since March 2021, the FED has purchased $80 billion in Treasury securities and $40 billion in mortgage-backed securities each month. The latter is one reason why mortgage rates are so low. Furthermore, the FED cut short-term rates to zero.

As the economy continues to strengthen, the Federal Reserve Bank (FED) has signaled that it will start reducing the amount of stimulus it is pumping into the system. This action is known as tapering. The tapering will hopefully be gradual and in stages. For example, bond purchases will likely be reduced first, followed by increasing the short-term lending rate between banks.

Stock and bond markets will digest this information. These markets will be more volatile due to the tapering; however, it should be temporary. The economy is in good shape, and more government stimulus is on the way in the form of a $1 Trillion infrastructure bill. Infrastructure money takes time to work its way into the system, but it should smooth out some impacts of tapering. The bill still needs to pass the House of Representatives. It’s possible that the bill will not pass as Nancy Pelosi is vowing not to let it pass unless a $3.5 Trillion budget resolution passes to expand entitlement programs such as social security, Medicaid, and clean energy initiatives. Passing both bills may be problematic as the FED may need to taper faster if inflation becomes an issue due. I don’t believe the stock and bond markets need either of the bills for support. However, there may be temporary volatility if these bills don’t make it through the House of Representatives.

ETF Spotlight

iShares Emerging Market ETF was the best performer this week. This index is market-cap-weighted, and larger companies have greater weighting. As you can see below, the index has been dropping over the past couple months. This is primarily due to the Chinese government starting to regulate technology companies. The top 5 markets which are China, Taiwan, South Korea, India, and Brazil make up 71% of the holdings.