Is Tapering Tightening? Or Is Tapering Less Easing?

As central banks pare back their asset purchases, the process will have the effect of slowing the decline in the stock of bonds that the private sector needs to hold relative to when the central bank was buying bonds more aggressively. This dynamic suggests that the tapering process should be characterized as less easing, rather than outright tightening.

However, tapering could be characterized as tightening if the central bank is using it as a signal for eventual liftoff.

The Fed has been actively separating the tapering decision from the liftoff one, and in the process detaching this signal. Thus, a tapering announcement this year does not reveal anything about the timing of the first-rate hike. However, given that the Fed intends to bring down its asset purchases to net zero before increasing rates, the tapering timeline could provide a signal about liftoff. If the timeline calls for an aggressive reduction in the pace of asset purchases and therefore targets an earlier date for net-zero purchases, then it would suggest that the Fed could raise rates earlier than under an alternative scenario in which the pace of reduction in asset purchases is more gradual.

Higher uncertainty amid the relatively weak August employment report – and the possibility that the setback in the labor market recovery could last a couple more months – suggests that for now, a tapering announcement should be interpreted as less easing, rather than as tightening.

BCA Research