To the surprise of many, the Fed
decided not to begin tapering QE3 at its meeting today. Personally, I expected a modest taper of $10 billion (in other words, it would start purchasing $75 billion worth of Treasuries and mortgage-backed securities each month instead of $85 billion). What happened? I think
many on the Fed had been concerned about excessive leverage and speculation in the system as evidenced by record-low long-term interest rates, record low interest rates on high-yield bonds, etc. Once the possibility of tapering began to be discussed, there was an unwinding of risk in financial markets (higher long-term interest rates (including mortgage rates), interest rates on high-yield bonds, etc.). Since this mission was accomplished, even more than what the Fed had expected, the Fed could turn its focus back to the economy. As discussed in previous posts, the economy is growing at a modest pace and there is question as to how much the spike in interest rates will affect economic growth in the coming months. Together with continued low inflation, the Fed felt comfortable delaying tapering until at least its next meeting.
Was this the correct move? It's debatable (I would have voted to taper a little). Hopefully it'll provide further stimulus to the housing market and the rest of the economy without reigniting excessive speculation; only time will tell. Financial markets have responded by increasing stock prices and oil prices by more than 1% (compared to before the announcement) while driving down the yield on the 10-year bond by about 0.2% (as of 3pm on September 18).
