What is Tapering?

Key Takeaways

● Tapering is the theoretical reversal of Quantitative Easing (QE) policies

● Tapering is not a tightening policy but a phase of a complete Quantitative Policy Cycle

● Tapering has an obvious impact on the gold, bond, and real estate market

Understanding

Before understanding tapering, we need to know Quantitative Easing (QE).

QE refers to a policy measure used by the central bank of a country to increase the supply of basic money by purchasing government bonds from banks, thereby increasing the amount of funds in the financial market.

Tapering refers to the process by which the central bank reduces the scale of QE until it no longer invests funds.

Typically, tapering occurs after some stimulus program has been operated.

A complete quantitative policy cycle includes Quantitative Easing (QE), Exit Quantitative Easing (Tapering), and Quantitative Tightening (QT).

So, Tapering is not a tightening policy, but a process in which the Fed gradually reduces asset purchases until it no longer purchases new assets.

Tapering's impact

From a historical perspective, Tapering has a relatively obvious impact on the following three types of assets:

First, gold.

The withdrawal of monetary stimulus policies and the improvement of the economy, are not conducive to the price of gold.

"In the short-term, gold could remain under pressure because a lot of central banks will be tilted toward normalizing monetary policy, gradually tapering their asset purchases, especially given higher inflation," Hitesh Jain, lead analyst at Mumbai-based Yes Securities, said.

Reduced stimulus and interest rate hikes tend to push government bond yields up, raising the opportunity cost of holding non-yielding bullion.

Second, bonds.

The Fed’s reduction in asset purchases directly affects the demand for U.S. Treasury bonds.

Typically, yields would rise once the biggest buyer in the marketplace steps away, which could cause mortgage and refinance rates also to go up. But investors also take into account their expectations for inflation when buying Treasurys.

Third, real estate.

Housing prices are up 18.5% from the end of 2020 to the end of 2021, and interest rates are increasing. The 10-year Treasury and mortgage rates are up 110 and 125 basis points, respectively, from late 2020 to February 2022. As a result, affordability has worsened; the payment on a 30-year fixed rate mortgage would cost over 39% more for the same home from late 2020 to Feb 2022.

We would expect these hefty increases in interest rates to challenge affordability and slow home-price appreciation despite income gains and a stronger economy. While the rate of home-price appreciation could fall dramatically, it’s hard to envision outright declines in prices given the tight inventory.

Bottom line:

Even though Tapering is not yet tightening, it represents expectations for monetary policy normalization, especially given that asset valuations are currently at historically high quintiles. Therefore, the impact of the Tapering process on asset price fluctuations cannot be ignored.