“Fed Tapering means the gradual reduction in the size of the assets purchased by the central bank to remove liquidity. This can result in the market of risky assets such as crypto to take a plunge and the effects are evident nowadays as the feds have begun Tapering”.
What is Fed Tapering?
The word ‘Taper’ means ‘to gradually reduce or shrink’ and in financial terms Fed Tapering means the gradual reduction in the size of the assets purchased by the central bank to remove liquidity. It is the exact opposite of ‘Quantitative Easing’. The central bank will usually implement quantitative easing, to purchase large amounts of medium and long-term bonds such as Treasuries in order to anchor low or even zero interest rates for a long period of time. This was done in March 2020 in the wake of Covid19 Pandemic as it is also known as ‘Money Printing policy’. Quantitative easing has a profound effect on the economy as it increases the risks of inflation and thus Fed Tapering is done to reduce this easing by reducing the liquidity from the market.
How is Tapering Done?
The Fed Tapering is done in steps to ensure that there is no panic in the market. The following steps are taken by the Federal Reserve to gradually tighten its policies:
- Release Tapering Signals: The Federal Reserve first releases the signals regarding tampering so that the investors and the economy gets time to get ready to react to the upcoming tapering. This was done in September when $15 Billion per month tapering was announced.
- Formal Tapering: In this step the actual tapering is done which is also a gradual step by step approach and Feds can even increase the speed of tapering when required as was done on 16th December by doubling the tapering to $30 Billion per month starting in January 2022.
- Interest Rate Hike Announcement: In this step the interest rate hike will be announced first to prevent panic and to give time to the economy to prepare itself. It is expected to be done around May next year.
- Formal Interest Rate Hike: In this step, a gradual hike in the rate of interest will be done by the Federal Reserve. It is expected to start by the mid of 2022.
- Shrink Fed’s Balance Sheet: At last the Feds will announce the shrinking of their balance sheet to complete the cycle. This step is expected to be taken around 2023 and beyond.
How will it Affect Crypto Market?
Fed Tapering is tightening of the monetary policies and thus in simple terms it means that there will be better returns on the long term bonds and Government securities which are risk free, and thus the markets of all the risky assets have a risk of taking a plunge. The stock market as well as crypto market can see drops in investment and even sell off by certain investors to invest in a risk free asset with good rate of interest.
The effect has started to show as the crypto market fell sharply before the Fed’s meeting on 16th December in anticipation of rapid tapering by the Feds.
Disclaimer: The article is meant for the educational purpose only and in no way it should be considered as financial advice. Own research on the topic is advisable.
Photo by – Karolina bedanken on Pixabay