The prospect of the Federal Reserve tightening the policy stance, with a triple action process, Triple Threat has caused a wave of worry and uncertainty across the market-leading it to overreact in anticipation.
The reserve banks around the world always have a keen eye on the policy stance undertaken by the Federal Reserve of the USA. This is due to the fact that the policy stances by the central bank of the USA have an effect on the economies around the world due to widespread globalization, which has led to the development of interdependence among the nations around the world.
The prospect of the Federal Reserve tightening monetary policy stance, by not only causing an increase in the interest rate but also by going for taper asset purchase which has led to speculation of the third process of balance sheet reduction, popularly termed as the “triple threat, has taken the markets by storms, causing them to overreact in anticipation of effects of the policy action.
The Federal Reserve had been on an accommodative monetary policy mode for the last two years and most of the time after the great recession, to give the economy a breather in order to recover. But as the economy is back on the growth path the Fed has been making slow but sure steps with respect to increasing interest rates.
It has reduced the number of bonds it used to buy every month. Other than this, the investors are anticipating a tapering bond-buying and reduction in the holding of treasury and mortgage-backed securities, which would lead to a reduction of $9trillion in the assets with the Fed. All these steps are undertaken to put a constraint on the inflationary tendencies, which are brewing up as the job market recovers.
The overreaction is due to the fact that even though the investors expected all the policy actions they didn’t expect all of them to be undertaken simultaneously, which was indicated by the minutes of the meeting, from the recent meeting of the Fed. This knee-jerk reaction is due to the fears of instantaneous reduction of liquidity in the market. The investors point to the fact that a gradual reduction in the liquidity could be accommodated by the market efficiency but the instantaneous reduction would cause issues.
But there are other factors that the Fed might be considering and may cause a delay in the tightening stance, the Omicron Variant. If the virus variant is prevalent in the economy, then it would be irrational to tighten as the economy would itself be under stress for a considerable time period due to hysteresis- effect, which would lead to delays in the economic processes, temporarily. Hence, the FED would take efficient policy action to support the American Economy.