A Tale of Two Tapers

CAMBRIDGE – The United States Federal Reserve and the People’s Bank of China are not typically seen as two peas in a pod. But they have had similar experiences in recent weeks – and neither has been a pleasant one.

The Fed’s bout of indigestion started with Chairman Ben Bernanke’s June 19 press conference, where he warned that the Fed’s purchases of long-term securities might start to taper off if the economy continued to perform well – specifically, if unemployment fell to 7%. Stock prices swooned. Yields on US Treasuries spiked. Emerging-market currencies weakened on fears that capital flows from the US would reverse direction.

Indeed, the reaction was so extreme and alarming that a parade of Fed officials felt compelled to clarify. To say that the Fed’s policy of “quantitative easing” might taper off, they explained, was different from saying that it would be halted. When and how purchases of long-term securities were reduced would depend on incoming data. In particular, there was no guarantee that 7% unemployment would be reached before the end of the year.

By coincidence, June 19 was the same day that the People’s Bank of China decided not to provide additional liquidity to the country’s strained credit markets. The interest rate that Chinese banks charge one another for short-term loans had begun rising two weeks earlier on rumors that two medium-size banks had defaulted on their debts. The interbank rate went from 5% to nearly 7%. Investors expected that the PBOC would step in, as always, to prevent rates from rising further and slowing the economy’s growth.