In the weeks leading up to the June 18-19, 2013, FOMC meeting, financial markets were fixated on the possibility that the FOMC would soon begin to slow the pace of its large-scale asset purchase program—which at that point was $85 billion per month. In his press conference following this meeting, Chairman Bernanke said that “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” By the time the FOMC finally voted to slow the pace of its asset purchases at the conclusion of its December 17-18 meeting, the 10-year Treasury yield had risen from 1.66 percent on May 2 to 2.85 percent on December 18. The period of rising interest rates before the FOMC began to officially slow the pace of its asset purchases is sometimes referred to as the “taper tantrum.” This development led some analysts to conclude that financial markets would not react well when the real tapering got underway. Well, it hasn’t quite worked out that way.
This graph plots the St. Louis Fed’s Financial Stress Index (STLFSI) since Oct. 1, 2009. In the STLFSI, values above zero are defined as periods of above-average levels of financial market stress and values below zero are defined as periods of below-average levels of stress. Zero is considered average. The STLFSI rose sharply (became less negative) from the week ending May 17 to the week ending July 5. However, since early July it has steadily drifted lower. Moreover, since the December 2013 meeting, when the FOMC first voted to reduce the pace of its asset purchases by $10 billion per month, the STLFSI has fallen even further. Indeed, for the week ending April 25, 2014, the STLFSI was at its lowest level since mid-March 2013. All of this suggests that the Fed’s decision to steadily slow the pace of its asset purchases—currently $45 billion per month after the conclusion of the April 29-30 FOMC meeting—is having little adverse effect on financial markets.
An alternative, though perhaps complimentary view, is that the markets see what the Fed sees: A steadily improving economy and a continued low and stable inflation outlook.
How this graph was created: In FRED, enter “St. Louis Fed Financial Stress Index” in the search box. The data are in levels (no transformation). The beginning period was adjusted to show data since Oct. 1, 2009.
Suggested by Kevin Kliesen