Narwhal Finance Word of the Week: Tapering

Welcome to the inaugural edition of Narwhal’s new series: The Narwhal Finance Word of the Week (or NFWOTW for short). This series of short blog posts aims to promote the financial literacy of our clients by selecting one word from the world of finance to briefly define and discuss each week. We hope that these posts can be an easy and fun way to upgrade your finance vocabulary so that you can be a more informed investor and, more importantly, dominate your colleagues during water cooler conversations at work. So, without further ado, let’s introduce our first NFWOTW: tapering.

Simply put, as it relates to markets, tapering refers to the Federal Reserve slowing the rate at which they purchase Treasury Bonds and Mortgage-Backed Securities. These purchases are commonly referred to as Quantitative Easement or QE, which is essentially a fancy finance term for pumping cash into the economy. QE is a useful tool because it allows the Fed to manipulate the bond market to artificially keep interest rates low in times of economic hardship. When the Fed buys a large number of bonds, in theory, the money supply increases, interest rates stabilize, and it becomes easier for regular people like you and me to borrow money for important purchases such as buying a house. It also helps businesses because they can borrow more money to boost short-term production at low long-term costs. All of this is supposed to help spur the economy toward investment, which is critical for any country that is on the path to economic recovery.

Now, this all might seem like abstract economic theory, and you may be asking yourself why you have bothered to read this far already. Sit tight, we’re getting there. Tapering is relevant today because it could potentially become a huge determining factor in market sentiment over the next few months. In short, when the Fed begins tapering, the flow of money in the economy tightens. The Fed begins tapering when they begin to fear that their QE activities are putting too much money into the economy and thereby causing inflation. If you have been reading Narwhal’s weekly Macro Sheet posts by our very own, Ben Nye (shameless plug: they are really helpful for understanding basic trends we are seeing in the economy week-to-week), then you know that inflation has become a hot topic of sorts over the past few months. The Fed has picked up on this as well, and they recently hinted that they will begin the tapering process sometime in the near future in order to keep the economy from overheating. The concern is that last time the Fed made this announcement, it was 2013 and it sparked a massive overreaction amongst investors that is affectionately referred to as the Taper Tantrum. Essentially, people were scared that tapering would cause interest rates to skyrocket so they began to rapidly sell their bonds off. Ironically, it was the panic of the Tantrum that caused interest rates to rise rather than the tapering process itself.

Most people are hopeful that things will go differently this time, as the prevailing narrative is that the Fed will begin with tapering their purchases of Mortgage-Backed securities first to cool the red-hot housing market, and then move on to tapering Treasury purchases. Hopefully, this will help slowly wean the market off government support in a manner that avoids a market crash or a Taper Tantrum 2.0, but the details of the Fed’s tapering plan have yet to be disclosed. Stay tuned for more inciteful Narwhal blog post content on this issue, as I’m sure we will have more to say as the situation plays itself out in the coming weeks. In the meantime, we hope you have enjoyed the first installment of Narwhal’s Finance Word of the Week, and we look forward to continuing the series next week and in the weeks to come!

Big shoutout to Tom Russell, our Director of Fixed Income, for doing most of the heavy lifting for this article. You’re the man, Tom!