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What If the Fed Does Taper QE? 8 Possible Scenarios


A look at the Fed's possible coming actions and the way they could affect the markets.

What are the possible scenarios for the Fed? Most importantly, the so-called tapering can be significant, negligible, or nonexistent. It can be started because of optimism about the state of affairs, or pessimism because of ineffectiveness of the tools. It can also be done at different times. Moreover the Fed can offer different communications about the program.

We can think of various scenarios:
1. The Fed continues the programs and communicates to the public that not much has changed.

2. The Fed continues the program and communicates to the people that the program is being reduced because things are going great (economy is improving, unemployment is lower etc.).

3. The Fed continues the program and communicates to the people that the program is being reduced because of possible threats (e.g. inflation).

4. The Fed freezes the program and communicates to the people that things are going well.

5. The Fed freezes the program and communicates to the people that things are not very good (risk associated with the program are higher than benefits).

6. The Fed decides to reduce its holdings and communicates that things are going great.

7. The Fed reduces the holdings and communicates that it's because things are not going well.

8. The Fed will not change anything, but at the same time will think of something "special," perhaps some other tools. They can start some other programs instead of dealing with existing ones.

In today's article we will feature one of these scenarios in greater detail. Namely, we will discuss what would likely happen if the Fed froze the program and went into "standby" mode because of positive news. That's what corresponds to scenario No. 4 from the above list.

In scenarios No. 4 and No. 5, the Fed is moving to the standby position. It freezes its balance sheet, and decides to step back from continuous buying of securities, both governmental and mortgage. The communication in this case is the most important factor. In the fourth scenario the program is tapered, and the argument is made that the reason for this is that the economy has improved. The information is the following: The dollar system is in a better condition. Gold would probably go down under that scenario since it would lose parts of its appeal associated with its anti-dollar nature. The other markets would probably react positively in the medium term, especially Treasuries and the stock market.

It is also the case with real estate, but much less so. If the Fed stopped buying more mortgage securities, then leaving them in the market should lead to a downward pressure, right? Yes, but we have to accept that there are some small positive movements in the real estate. Probably not that definite, and we should still see a lot of things happening in the market. Nevertheless our decision to put an "upward pressure" comes from the fact that the Fed slowed down recently in the buying of commercial assets (at least if one compares the actions to the previous plans).

Therefore there is some paradox in the above table. We see more chances that real estate should grow under the freezing scenario than under the continuation scenario. Why? Simply put, if the Fed officially slows down its operations and communicates the case because of positives, then it may be a sign that there is some life in the real estate market (plus, standby means that government is ready to help at any time if things get worse). Whereas with the continuation program, an additional buying scenario, it will probably mean that there is much less life in the real estate, and the Fed is trying to continue a hopeless fight against market forces.

Summing up, what would likely happen if the Fed does indeed taper the QE program? Gold would likely suffer in the medium term, but other markets would likely thrive (even though no one can rule out a short-term upswing).

Matt Machaj, PhD, is an economist whose research is focused on the monetary policy, the gold standard, and alternative monetary regimes. Matt is a university professor, blogger, publicist, founder of the Polish Mises Institute branch, member of Property and Freedom Society, and laureate of Lawrence Fertig Award.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
No positions in stocks mentioned.
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