Image shows a picture of Lindsey Bell, Ally Invest’s chief investment strategist. The title reads “Tapering 101: What to Know About the Fed.”

The Fed is moving markets again.

The S&P 500 posted its worst day in a month on Wednesday after notes from the last Fed meeting signaled tapering could start before the end of this year. Investors are having flashbacks to 2013 when the market fell as tapering talk began. And with growth worries escalating once again, some fear the Fed is reducing stimulus too soon.

It’s safe to say tapering is one of the biggest worries for Wall Street. And you may have never heard of it.

Tapering is the Federal Reserve’s first step toward removing its historic pandemic support from markets by gradually decreasing its $120 billion in monthly bond purchases, which helped put the economy on solid footing in the wake of the pandemic.

Chart titled $8 Trillion in Fed Help tracks Treasuries, mortgage-backed securities and other assets from 2009 to 2021. All three categories have generally risen before taking a dip in early 2020. However, since COVID began, the Fed’s balance sheet has doubled to $8 trillion. Source: Ally Invest, Bloomberg

Next week could be pivotal, too. Fed Chair Jay Powell speaks at the Economic Policy Symposium in Jackson Hole, an annual event for central bankers that’s evoked some big headlines in the past.

Tapering is a small change that could have big repercussions. A Fed stumble could rattle markets and dampen growth. But tapering isn’t necessarily worth panicking over just yet.

This week, we’ll answer all your burning questions about tapering.

How has tapering worked in the past?

Tapering, in this context and magnitude, has only happened one other time in history: the Great Financial Crisis recovery. And that time, it was all bark and no bite.

In early 2014, the Fed started scaling back its $80 billion a month in bond purchases by $10 billion a month, more than four years into the business cycle. In the year before, there was a lot of speculation and nervousness around tapering because it was the first time the Fed would undergo such a drastic change in policy. Rates even went through a rough period called the “taper tantrum,” with the 10-year yield spiking more than 1.3 percentage points from May to September 2013.

But the taper itself was a non-event. The S&P 500 clocked an impressive 11% return in 2014 with no selloffs larger than 8%. The 10-year yield fell that year, even with less Fed help.

Graph titled All Bark, No Bite charts the S&P 500 during the last Fed taper (2013–2014). In May 2013, Fed Chair Ben Bernanke told Congress that the Fed could start reducing bond purchases “in the next few meetings.” Between then and January 2014, the 10-year yield grew +0.98 percentage points. In January 2014, the Fed started to taper bond purchases by $10 billion per month. Between then and October 2014, the 10-year yield fell -0.66 percentage points. In October 2014, the Fed finished its bond purchasing program. Source: Ally Invest, Bloomberg

It’s possible we’re seeing the same pattern today. Rates have had a rollercoaster of a year, presumably on Fed speculation and inflation fears. The 10-year yield is back near historic lows, but there are several forces that could keep yields low even if tapering upends the market.

Just remember, we’ve been through this before.

When is this happening?

Nobody knows for sure, and we’re getting a lot of mixed signals.

What gives?

These days, it’s difficult to know the right time for tapering. Most economic data looks solid, but some reports look too strong and others too weak. Plus, we’re still processing what the Delta variant flare-up could mean for the economy.

No matter what the timeline is, it’s typical for the Fed to give a heads up at least one meeting before making a policy change. If that’s the case, watch the September meeting to see if the Fed hints strongly toward a taper. That could set the Fed up to formally announce the taper in November and begin the process shortly thereafter.

Is the Fed making a mistake?

There’s always a chance the Fed makes a mistake. They’re human, just like us.

However, there could be a method to the madness. Powell and his crew have been talking publicly about tapering for a few months, and every governor seems to have a different opinion. This may be the Fed’s way of getting valuable feedback from investors before making a change, and it’d rather be overly transparent at the risk of a few down days. Fed officials may be trying to avoid the worst-case scenario: a surprise decision that leads to a complete loss of confidence.

What about rate hikes?

Tapering is another step toward rate hikes, but that doesn’t mean rate hikes are right around the corner. In the July meeting minutes, Fed governors were careful to dismiss the notion that they’d hike rates during (or right after) the taper.

It’s understandable to be worried about rate hikes. In the past, the Fed’s drastic rate hikes have toppled the economy. But it’s important to focus on the speed of rate hikes and level of rates instead of the event itself. Small, gradual rate hikes rarely upset growth, and this particular group of Fed officials likes to take things slow and steady. In the last business cycle, the Fed took eight months to wind down bond purchases, then waited another year to start hiking rates. That approach led to one of the longest economic expansions in history.

The Bottom Line

Part of being a wise investor requires sorting through which headlines are signal and noise. While tapering can have consequences, try not to get too caught up in speculation.

Don’t forget: Tapering is a good development for the economy. It shows the Fed feels confident enough in the recovery to pull back a bit of support. Conditions may not be perfect, but they could be strong enough to move from a wheelchair to some heavy-duty crutches, especially if it means keeping overheating symptoms like inflation at bay.

The Fed is doing its market research right now. We’re eagerly watching to see what happens next.

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Callie Cox, senior investment strategist, contributed to this article.

Speech bubble icon next to text "Expert Take"

Headshot of Lindsey BellLindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.

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