Yesterday afternoon the Federal Open Market Committee (FOMC) concluded their monthly meeting with an announcement that the federal reserve will begin tapering its long-running bond purchases this month. For an extended period of time, the Fed has been purchasing $120 billion per month of treasury and mortgage-backed securities. We will now see a reduction of $15 billion in that amount, to $105 billion in purchases per month.
This is an important policy change because the Fed’s purchases were made with money printed by the fed and purchases made through open market transactions. This has two effects.
- It artificially suppresses interest rates by providing a demand for bonds that works to keep their interest rates suppressed. With that demand gone, interest rate increases are an absolute certainty, as we have discussed over the last two years.
- Those purchases, via printed money, have been highly inflationary. The Fed’s reduction in those purchases will undoubtably lead to higher interest rates. In addition, due to the vast amount of currency injected into our economy from the money printing, high circulating cash will also result in continued historically high inflation rates.
Despite the current presidential administration’s assurances that inflation is “transitory”, (which has been echoed by the Treasury Department and the federal reserve) inflation increases are not transitory and are very likely embedded in our nation’s economy long term.
The investments that do best in this type of economic environment? Well-chosen and selected equities, particularly in the financial sector, where our firm has over 35% of our client’s assets allocated.
The Fed’s tapering is nothing to be concerned about or feared. Still, it does present challenges that rise from past federal reserve policies that lasted for too long, creating too much monetary (or money) supply, and left more assets chasing fewer available goods in a COVID environment. Ultimately this resulted in the substantial increase you see in the price of virtually everything sold in our country.
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