Phobia of US Tapering Off
The government, monetary authorities and business actors still have to be careful with the unforeseen risks of the tapering off. Tapering off is bound to happen, as this is a normal course of action. So, act normally.
In the last one or two months, we have been disturbed, anxious, and afraid of the impact of the tapering off measures that may soon be taken by the US Central Bank (The Fed).
The tapering off by the Fed is a gradual reduction in the purchase of securities. The Fed is trying to reduce its monetary stimulus or keep injecting US dollars into the US economy\'s financial system, albeit at a smaller rate. The massive and abundant injection of money supply to restore the US economy during an economic crisis will be reduced in scale, as simple as that.
Tapering off seems to disrupt the global economy, which is enjoying a recovery after the economic recession in 2020. Tapering off makes other economies feel like it’s the end of the world, for people who are not prepared physically and mentally.
The word tapering off should be handled fairly, wisely and carefully. Literally, tapering off means gradually decreasing. This explicitly reflects a slow and gradual decrease or reduction. Not sudden, not drastic reductions, which should not cause significant fluctuations or shocks in the economy.
Taper Tantrum 2013
Then, why does tapering off tend to be considered super-negatively by most investors and analysts? This is none other than the bad experience of the taper tantrum—the correction of the quantitative easing period in which the central bank bought the financial assets of commercial banks and other private institutions thereby increasing the money supply in the US economy in 2013—which has caused trauma to this day.
Let\'s see exactly what happened before the 2013 taper tantrum. The US economic crisis in 2008/2009 caused the Fed to take extreme steps in its monetary policy to save and restore the US economy. The Fed convincingly administered two “antibiotics” at once. First, lowering interest rates down close to zero percent by lowering them from 4.25 percent per December 2007 to 0.25 percent in December 2008. Down 4.0 percent in just one year. The low interest rate of 0.25 percent was maintained for seven years until November 2015.
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The second is the quantitative easing/QE policy (purchase of government and private securities by the Fed) which is supermassive. US dollar liquidity at that time poured into the US economy. US dollars that were disbursed were around US$3,607 billion during 2008-2014. As a result, the assets of the Fed increased significantly by 405 percent from US$891 billion in 2007 to US$4.49 billion in 2014.
These two “antibiotics” turned out to be quite effective in treating the US economy which was in recession in 2008/2009. The US economy gradually recovered, that\'s when the Fed tried to reduce the dose of its QE antibiotics, known as the 2013 taper tantrum. The market did not expect the Fed to taper off so quickly in December 2013. Pros and cons follow this policy. As a result, global financial markets were volatile, and foreign capital flowed from emerging markets to the US.
Impact on Indonesia
This condition greatly shook the Indonesian financial market. The yield on the 10-year tenor RI bonds was under intense pressure. The yield on 10-year bonds averaged 5.4 percent in the period before tapering off (December 2012-May 2013). Then it rose significantly by 2.4 percent to 7.8 percent in June-November 2013. And it was even more depressed in the tapering off period (December 2013-October 2014), with an average yield of 8.3 percent.
Shocks also occurred in the stock market, but not as severe as in the bond market. The average stock price index was 4,709 in the period before tapering off (December 2012-May 2013). Furthermore, it fell significantly by 4.7 percent to 4,490 in June-November 2013. Then the index recovered to 4,813 during tapering off (December 2013-October 2014). The volatility in the bond and stock markets caused the average exchange rate of the rupiah against the US dollar to weaken significantly by 20.8 percent from Rp 9,698 to Rp 11,814. This pressure continued after the tapering off to Rp 13,236 in the period November 2014-December 2015.
Given this condition and the turmoil that occurred in the bond, stock and rupiah exchange rates, it is natural that the negative impact of the 2013 taper tantrum left a deep impression and traumatized the national economy.
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The question is, why did the 2013 taper tantrum make the global financial market and Indonesia experience deep and very fluctuating pressure? Doesn\'t the literal meaning of tapering off mean a gradual, not sudden decrease in monetary stimulus? We suspect that there is a significant difference in perception between the market analysis and the Fed\'s decision regarding the US economic recovery. On the one hand, the Fed is quite confident that the US economy will recover very solidly, while market analysis seems to doubt it.
If we trace the trend of US economic indicators in detail, be they in terms of demand, supply, employment or inflation, it is evident that the US economic recovery is not solid, but tends to mix between one variable and other macroeconomic variables. For example, from the demand side, the trend of growth in retail sales tends to slow from 6.7 percent in December 2010 to 3.5 percent in December 2013. While motor vehicle sales increased from 12.4 million to 15, 5 million. In terms of inflation, it’s clear that domestic demand is not very strong, it was still far below 2 percent in December 2013.
What will happen now if the Fed will again conduct tapering off in the near future? It seems that the current condition of the US economy is much different from the 2013 taper tantrum. We think the negative impact of tapering off will not be as severe as the 2013 taper tantrum. The crucial point depends on the communication of the US Central Bank Governor Jeremy Powell. If this can be well communicated to market participants and the message is clear, we think the negative impact can be mitigated by many countries, including developing countries (Indonesia). Communication is very important and it is a high art. Communication is part of the policy that cannot be separated from the policy itself.
(FILES) In this file photo The Federal Reserve Board building is viewed on July 1, 2020 in Washington,DC. - The Federal Reserve opened its final day of policy deliberations on April 28, 2021 and is expected to reaffirm its commitment to sustaining stimulus to the US economy until it has recovered from the Covid-19 damage.But as the accelerating vaccination campaign offers hope life can return to normal following the disruptions caused by the pandemic, the Fed has to face down growing concerns that surging economic activity will ignite uncontrolled inflation.
US Recovery Very Solid
Various US macroeconomic indicators have recently shown a very clear trend of data development and a very solid economic recovery. First, from the demand side. Retail sales growth rose significantly from 2.3 percent in December 2010 to 51.2 percent in April 2021. Motor vehicle sales were very high at 16.3 million in December 2020 and rose again to 17 million in May 2021. Consumer confidence index also showed optimism over the last two months, namely 117 in April and May 2021, from pessimism of 87.1 in December 2020.
Second, from the offer side. Industrial production growth increased sharply from minus 3.2 percent in December 2020 to 16.5 percent in April 2021. Composite PMI (manufacturing and services) from 55.3 in December 2020 to 68.7 in May 2021 (in the expansion zone) and production capacity utilization in the range of 74 percent during the December 2020-April 2021 period.
Third, in terms of the labor market. The unemployment rate fell significantly from 6.7 percent in December 2020 to 5.8 percent in May 2021. Likewise, initial jobless claims fell sharply from 763 to 385 in the same period. Meanwhile, the pace of new job openings increased from 4.5 percent to 5.3 percent.
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Fourth, the trend of output gap data that reflects the difference between actual output and potential output. If the output gap is negative, it means that the actual output is below the potential output. On the other hand, a positive output gap means that the actual output is above the potential output. A good economy and in a positive trend is the output gap heading in a positive direction. It is evident that the US output gap tends to move in a positive direction. The US output gap was recorded at minus 10.1 percent in the second quarter of 2020, is expected to improve in the third quarter of 2021 by around minus 1.3 percent and continues to improve to minus 0.8 percent in the fourth quarter of 2022.
Based on very comprehensive data, we believe that market players have begun to anticipate (price in) that the US tapering off will be faster than previously estimated. The negative impact of tapering off should not be as bad as the 2013 taper tantrum. However, again, depending on smooth and effective communication from the Fed, when will the tapering off take place?
Anton Hendranata
The government, monetary authorities and business actors still have to be careful with the unforeseen risks of the tapering off. Tapering off is bound to happen, as this is a normal course of action. So, act normally and measuredly. The QE antibiotics must indeed be avoided so that the economy can grow naturally and sustainably, not continuously be given "doping".
Anton Hendranata, Chief Economist at Bank Rakyat Indonesia; Research Director of BRI Research Institute.
This article was translated by Kurniawan Siswoko.
