The big story of the week is the Federal Reserve. Everyone wants to know what Fed Chairman Ben Bernanke will indicate about "the taper" – the possible reduction of monthly bond purchases it's expected to make under its quantitative easing program later this year.
At the moment, the Fed purchases $85 billion worth of bonds in an effort to drive interest rates lower and inject liquidity in the market. Fears that the Fed will pull back on these purchases have caused Treasury bond yields to rise, in turn causing all kinds of ructions in global markets.
So why are people so concerned?
To help explain, we've employed 11 tapirs — which are pig-like jungle creatures — to convey the big fears about the taper.
1. This tapir is worried that the U.S. economy isn't ready for the Federal Reserve to begin tapering back monetary stimulus. With inflation falling and unemployment at 7.6%, the Fed is far from achieving its economic goals.
2. This tapir is worried that if economic weakness appears again, forcing the Fed to reverse its decision and increase the pace of its bond purchases, it could hurt the central bank's credibility.
3. This tapir is worried that when the Federal Reserve begins to taper back QE, it will remove liquidity from financial markets. As a result, some of the riskiest markets that tend to benefit most from extra liquidity could falter.
4. This tapir is worried that rising interest rates could present a headwind to the housing market by making mortgages more expensive.
5. This tapir is worried that mortgage refinancing activity would also slow substantially if interest rates were to rise. We've already seen refis plummet in the past month as rates have headed upward.
6. This tapir is worried that like mortgage rates, rates on other consumer loans – student and auto loans, for example – will go up as well, making borrowing for tuition or to buy a car less affordable.
7. This tapir is worried about what happens when rising interest rates force the Fed to take losses on its bond portfolio.
8. This tapir is worried that emerging markets will get crushed, as the massive liquidity unleashed by QE will reverse, causing money to head back to the US.
9. This tapir is worried that it's less about the stock of the Fed's bond purchases (the total amount of bonds in its portfolio) than the flow of purchases (i.e., how many additional purchases are made each month) that matters for the market. When the Fed tapers, the stock will still be increasing – the Fed will still be purchasing bonds – but the flow will be decreasing, because it will be buying less than it was before.
10. This tapir is worried that individual investors, which have undertaken a structural shift in their portfolios toward holding more and more bonds as prices have risen, will lose a lot of money on their investments when interest rates rise.
11. This tapir is worried about the hidden bubbles that will be revealed when interest rates begin to rise again. Low interest rates encourage the creation of complex investment vehicles designed to take advantage of leverage in order to boost returns. In some cases, rising interest rates may reveal bubbles that only become apparent after they have burst.
(Thanks to Stephen Gandel for providing the original inspiration)
