In the November Federal Reserve Open Market Committee (FOMC) meeting, Fed policymakers left interest rates near zero but also announced a plan to start winding down or ‘tapering’ its bond purchasing program .
What happens now?
The Fed has been purchasing $120 billion worth of bonds each month driving up bond prices . By buying bonds, the Fed was supplying the market with easy money and sending bond prices higher. Higher bond prices in turn lowers interest rates, as they move in the opposite direction. This program, known as quantitative easing (QE), was done initially in an effort to help the economy through the pandemic by injecting liquidity and stability in the markets. Thereafter, the program was maintained to drive strong economic growth by keeping borrowing costs low across the economy, since bond markets help determine the rates of consumer loans such as auto loans and home mortgages. The program was akin to a fire hose on the financial fire of this pandemic. Going forward, the Fed wants to turn down the full force of this fire hose. Starting November 2021, the Fed will reduce its bond purchases by $15 billion per month until it phases it out by mid-2022. The key is to understand that tapering does not mean the Fed stops purchasing assets, but it reduces the pace of expansion. The Fed also stated that it was willing to change the pace of its tapering if economic conditions warrant. Finally, the Fed also clarified that winding down its bond purchases does not imply an interest rate hike is imminent either.