Is It Time for a Taper Tantrum? By Anita Srivastava



Most people are aware of the stimulus package or the economic measures that were put together by the US government post the Financial Crisis and the Great Recession. More specifically on February 13, 2009, in direct response to the economic crisis and at the urging of President Obama, Congress passed the American Recovery and Reinvestment Act of 2009 (ARRA)[i]. The primary objective for ARRA was to save and create jobs immediately. The secondary objectives were to provide temporary relief programs for those most affected by the recession and to invest in long term growth with projects in infrastructure, education, health, and renewable energy. The approximate cost of the economic stimulus package was estimated to be $787 billion at the time of passage, later revised to $831 billion between 2009 and 2019[ii].

The rationale for ARRA is based on the Keynesian macroeconomic theory, which argues that, during recessions, the government should offset the decrease in private spending with an increase in public spending in order to save jobs and stop further economic deterioration. This act was similar to the New Deal enacted during the first term of Franklin D. Roosevelt in response to the Great depression. Much like the ARRA, the New Deal was enacted by US Congress to focus on the 3Rs of domestic programs – Relief, Recovery, and Reform. Many New Deal programs continue to remain active, with some even operating under the original names, including the Federal Deposit Insurance Corporation (FDIC), the Federal Crop Insurance Corporation (FCIC), the Federal Housing Administration (FHA), and the Tennessee Valley Authority (TVA). The largest programs still in existence today are the Social Security System and the Securities and Exchange Commission (SEC).

We have historical perspective to know how the New Deal worked and how it didn’t. But how about the new ARRA of 2009? How does it work and has it affected the economic life of an average American? Here is one way how it works – To stimulate the economy the Federal Reserve Bank engages in activities that boost the economy back up by giving everyone extra money. This extra money is spent, loaned, saved, and used to increase cash flow. Businesses are given a kick start because people start spending money; businesses in turn need to buy more supplies so manufacturers are given a boost because they have more business and have to hire more people to make the goods that people want. All in all, the economy gets a nudge back in the right direction. That was essentially QE1. This was followed by QE2 where the Fed bought $600 billion of U.S. Treasuries and in QE3 Fed bought Mortgage Backed Securities in an effort to support the housing market. All of these programs essentially went unnoticed; however their effects had a strong impact on the non-financial sector of the economy and the average Joe and Jane.

When the Fed was pumping money into the economy, life seemed pretty good. Everyone got more money (well at least in theory), businesses started booming, and things such as loans and mortgages began to flow smoothly once people started getting jobs[iii]. The point to underscore here is that these Quantitative Easing (QE) measures were never meant to be long-term solutions, and as a matter of fact, can become very dangerous to the value of the dollar and inflation if they are left going for too long.

Impending rate hike by the Fed (Federal Reserve Bank).

Now more confident about prospects for growth and inflation, policy makers are preparing to raise those short-term rates. What does this mean for the average investor? Higher borrowing costs for banks can cause other forms of borrowing by the public such as mortgages and loans to jump up, decreasing new investment and entrepreneurial activity, making jobs scarcer, and the stocks to take a beating due to lowered growth and earnings forecast. But these don’t have to happen, especially with the severity as described and discussed ad nauseam by the media. However it can be very dangerous if the Fed raises interest rates too dramatically or cuts off easing too quickly. Obviously to alleviate this concern, the Fed will try and curtail its bond buying program, which is called "tapering”, and instead of suddenly stopping their easing programs, the Fed will slowly wind them down.

Unfortunately, much like a child, the stock and bond markets can be quite fickle, often overreacting to small changes and news that was intended to have a relatively benign impact on investors’ personal positions. Back in 2013 the Fed turned off one of their QE programs (or rather tapered it off). No sooner was the news announced than people panicked and money started pouring out of the bond market. The result was that bond yields increased dramatically. Over time investor fear leveled out and investors calmed as they realized that there was no need for mass hysteria.

Now the question is, are we are poised for a second Taper Tantrum? There is a lot of speculation that the Fed will raise interest rates. The target federal funds rate, which is set by the Federal Reserve Board, serves as the basis for the prime rate. The prime rate is a reference base rate that banks use to charge on commercial loans and some of their consumer loan products[iv]. The higher the prime rate, the more individuals must spend on loans.

When rates do go up, markets are bound to react – and perhaps even over react with yet another Taper Tantrum. Money will flow out of the bond market, yields will increase, and investors will wonder if we are plunging into another recession. There might be a few months of speculation, claims that the sky is falling, and mayhem before things will return to normal (barring other outside and unforeseen factors).

How will you be affected by this potential Taper Tantrum?

Those of you who are trying to get loans won’t be happy as you might be locked into a higher interest rate. Bond markets will likely see large fluctuations in prices and yields. Stock markets might do their own gyrations. How your individual portfolio is affected will depend on how you are invested, and what your goals may be. If you plan to retire in the next year or so, then now is a good time to worry about a Taper Tantrum. Since it is such a complicated subject, containing many moving parts and a number of variables, you should sit down with your financial advisor and develop a plan and a portfolio devised for riding out the storm. If you don’t plan to retire any time soon (or you don’t need to dip into your investments) then you should keep in mind your long term objectives and stay with your established financial plan. It is worth noting that small market downturns can be very good opportunities for those with plenty of time before they need their investments, due to the large upside potential. You would probably want some insights on how best to take advantage of that situation if and when it happens.

And what if the Taper Tantrum is averted? If the Fed can figure out a way to raise interest rates and mitigate the effects, the tantrum will barely be felt. Albeit the likelihood of that is rather small your best bet is to keep an eye on the way things are going, have a solid plan for your investments and goals and have a disciplined process that guides your decisions rather than investing on emotion; which, tantrum or not, has always been a losing proposition.


Anita Srivastava is a Financial Advisor with the Global Wealth Management Division of Morgan Stanley in Ridgewood, NJ. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives.

[i] Summary: American Recovery and Reinvestment" (PDF). U.S. House of Representatives Committee on Appropriations. February 13, 2009. Archived (PDF) from the original on February 16, 2009. Retrieved September 11, 2015.

[ii] CBO Report Feb 2012

[iii] Total nonfarm payroll employment increased by 173,000 in August 2015, and the unemployment rate edged down to 5.1 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care and social assistance and in financial activities. Manufacturing and mining lost jobs. US Department of Labor – Bureau of Labor Statistics. Economic News Release 8:30am (EDT), September 4, 2015.

[iii] Dr. ECON at the Federal Reserve Bank of San Francisco archived June 2005 and retrieved on September 15th 2015. http://www.frbsf.org/education/publications/doctor-econ/2005/june/prime-interest-rate

Anita Srivastava is a Financial Advisor with the Global Wealth Management Division of Morgan Stanley in Ridgewood, NJ. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, or its affiliates

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