Tapering is undoubtedly the buzz-word of economic reports right now, with all eyes focused on the US Federal Reserve and the plans of soon-to-be-replaced Chairman Ben Bernanke. The question remains however; what exactly is tapering, and why is it alleged that its effects will be felt across the globe?

Currently, the Fed is pursuing a policy of quantitative easing, a strategy in which the government purchase of assets such as bonds helps to both pump money into the American economy and reduce borrowing costs. This is generally seen to be an unconventional method of stimulus; the usual method is to cut interest rates, but they were brought to a low of just 0.25 percent in the wake of the 08-09 financial crisis. They cannot realistically be brought lower.

Tapering is quite simply a reduction of this scheme. As things stand, the Federal Reserve is purchasing $85 billion in assets, but it is likely to be reduced to around $65 billion in the near future. This is seen as a way of tightening things up, with the whole initiative potentially ending mid-2014.

Tapering Worries

So why is taper terror gripping markets all over the world?

The simple fact is that the Fed’s asset purchase scheme makes the USA less attractive to those who want to invest their money rather than borrow it. When tapering begins, and ultimately when so-called QE-infinityends, the USA is likely to begin drawing in more foreign investment. This is potentially bad news for numerous economies, as there could well be an outflow of capital as people and organisations move their money back into America and away from less secure investments.

Hardest hit are likely to be the emerging economies such as India, Brazil, and much of South East Asia. While their appeal was strong just a year or two ago, it has since faded considerably, and the threat of tapering has already had a significant effect. The Indian rupee in particular is extremely weak against the dollar.

Each time the Federal Reserve Open Market Committee meets, the markets become nervous, as the released minutes give an insight into the board’s thoughts on tapering. As things stand, the Fed will not begin to slow down their program until acceptable data is released, which shows that the US economy is on track and strong.

To give an example of just how tense the situation is, just a few days ago, data released showed that the US jobs market is performing better than had been predicted, which had prompted some speculation that tapering will come in December. This sent both the Indian rupee and the Indonesian rupiah down lower. On Wednesday however, Janet Yellen, who is due to replace Ben Bernanke, suggested that she might continue stimulus, which sent both currencies back up higher. Each little piece of information can change the whole market outlook, and it’s proving increasingly difficult to predict exactly what will happen. This lack of clarity is in itself a problem.

Potential Impact

The actual physical effects of investment leaving emerging economies will certainly vary. Several economists have asserted that India actually has little to fear if and when the USA’s asset purchase programme begins to be scaled back. Primarily this is because the RBI has taken precautions in the run-up, but also because upcoming elections are actually seen as the primary market mover.

More vulnerable are South East Asian economies such as Indonesia and Malaysia are unlikely to fare as well. They’re currently facing significant difficulties and are part of a large bubble economy, which could well pop if the effects of tapering are dramatic.

The final point however is that it could be an extremely long time before we actually see QE end in the USA, especially given Yellen’s attitudes. A $10-20 billion drop in the asset purchase volume might not actually be significant enough to reduce liquidity in all emerging markets.

To conclude, tapering certainly is a significant issue, but it won’t necessarily have the same impact everywhere. Avoid the hype.