Video of the Week – FED Does Not Taper

Unfortunately, I’m two days late in posting the Video of the Week. I was out of town and did not have access to the internet. But better late than never.

When I was first writing this post, I went into great detail to explain Quantitative Easing (QE) for those of you that might not be familiar with it. QE is basically a bond buying program first enacted by the Federal Reserve in 2008 in order to help the US economy recover. If you have no clue what QE is, instead of me rambling on and on, I think it would be better if you watch this short and simple explanatory video by Marketplace. Its actually quite entertaining.

Bernanke stated in May of this year that because of the positive trend in US economic performance, the FED was contemplating reducing, or as Bernanke put it “tapering” the level of QE later this year. There are key indicators that the FED takes into account.

1) The Unemployment Rate
When the latest  version of QE was announced in September of 2012, the FED stated that they would end the program when the unemployment rate fell to 6.5%. Since the start of the financial crisis, unemployment has fallen from a peak of 10% in 2009 to 7.6% as of last month.

2) Inflation
Many critics of QE thought the excess money in the economy would cause inflation to rocket. However, since 2008, inflation has remained low. The FED also stated that they would maintain QE as long as inflation remained below 2%.

3) Manufacturing, Housing, Stock Markets
Manufacturing indices, housing starts and prices, and the stock markets have all experienced an upward trend since 2008. The indicators to observe here are the ISM Manufacturing Index, the S%P/Case Shiller House Price Index, and the S%P 500 stock market index

Thus, markets were expecting a taper announcement after the FED’s Open Market Committee meeting last week. However, as the Video of the Week shows, Bernanke decided to carry on full speed and not taper QE. Well why did Captain Picard with an awesome beard do this? As he says in his speech, despite the positive outlook, the US economy. still faces some issues.

Firstly, even though the unemployment rate has been dropping steadily, the labor force participation rate has actually declined. This means that one of the reasons that the unemployment rate is falling is because more and more people are giving up on looking for a job. Thus they are dropping out of the labor force. Due to the way the unemployment rate is calculated, these people are taken out of the unemployment rate.

Secondly, inflation is still well below the FED’s 2% objective. If FED reduces QE, inflation might drop even further and this might eventually lead to deflation, which is a lot worse.

Finally, there is still ongoing debates in Congress regarding the debt ceiling which provides an onset of risk on the US economy.

“But why does this all matter?” you might ask. “I want the 4 minutes back I spent to read this post so I can watch Youtube videos of cats” you might say. Well,  Bernanke’s speech caused the US Dollar to lose value in the currency markets, the stock market to rise, and bond yields to drop. How do I know this? Well the S&P 500 index rocketed, not to mention stock markets around the world. Additionally, the US dollar gained in value versus other currencies, and the interest rate on Treasury bonds fell. However, make no mistake. This is only temporary. The taper is inevitable. The US economy is slowly and steadily improving. The FED will taper and sooner or later end QE. This will have the opposite effect of what happened this week. The US Dollar will gain in value, stock markets will face a downward risk, and interest rates will rise.

“Whatever the Federal Open Market Committee may say now about its plans for 2014 or 2015, it can always do something different when the future turns into the present.”
-Paul Krugman


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