In our previous article, we explained how the United States normalising its monetary policy impacts Singaporeans. The recent announcement by the United States Federal Reserve to taper its Quantitative Easing 3 (QE3) is one of the measures it is taking to normalise its monetary policy.

Does this have anything to do with the average Kopitiam Uncle? You bet. Let’s find out how and why.

Disclaimer: Many concepts and terms explained here are over-simplified to give readers a rough idea of what has been happening to the global economy in recent times. If you want an in-depth understanding on this issue, a more authoritative source would definitely be the library or business journals or financial newspapers. Unless you’re a kopitiam uncle and the kopitiam is the place you’d rather be.

Kopitiam uncle: I remembered last time you said that QE3 meant that the US was pumping $85 billion a month into the US economy. Now they say they are going to taper. What does it mean? Put scotch tape?

The federal reserve has just announced that they will lower the amount they are pumping into the US economy from $85 billion a month to $75 billion a month. They have not announced when this pumping of money will cease.

Kopitiam uncle: In June this year, the botak ang moh guy (Ben Bernanke of the Federal Reserve) hinted that he wanted to taper the QE 3 already. At that time the markets reacted badly leh. I heard over $3 trillion was lost in paper value. How come this time around he so brave, say taper means taper? Did a lot of people lose money like that?

There was one major thing that was different in the US between June and yesterday's announcement - US unemployment rate. It was 7.6 per cent in June and 7 per cent in November. This fall in unemployment signals that the US economy might really be on its way to recovery.

In June, with unemployment going at 7.6 per cent, the investors were not confident about the US economy. Hence, news of the potential cut in Government funds spooked investors - they were worried that the cut in funding may be detrimental to companies relying on the Government funds to stay afloat.

Bernanke's announcement yesterday was viewed with confidence that the worst of the fallout from the economic crisis may be over. This in turn signaled that the US economy may be able to slowly sustain itself without the need for Government QE funds. Investors' positive reactions could be seen from the Standard & Poor’s 500 Index rising 1.7 percent yesterday to 1,810.65, its biggest gain in two months.

Kopitiam uncle: The last time you mentioned that pumping money will keep interest rates low. Now that they are pumping lesser money, what will interest rates be like? My Ah Long will come look for me earlier not?

Another crucial piece of the puzzle of why the markets reacted so differently in June compared to yesterday has to do with interest rates. In June, Bernanke's stance was that long term interest rates would definitely increase - without giving ample information on when the increase would take place. Higher interest rates would hamper businesses' ability for growth and thus investors were not confident to put their money in them.

Yesterday however, he gave reassurance that interest rates would be kept low so long as unemployment rates are above 6.5 per cent and they have not met the 2 per cent inflation target. Currently unemployment is at 7 per cent while inflation is 0.7 per cent. This gave investors a clearer picture on when interest rates will likely rise - and it will rise eventually.

Kopitiam uncle: Now seems like a very good time to whack some money into stocks! Everyone seems so confident! My CPF also maturing already, if not now, later I may waste it on some of the ladies in Chinatown. Do I go in or not?

As always, before investing any money, proper research needs to be done.

It is not known whether the growth that the US stock market is experiencing now is genuine growth by companies or growing from the pent up investors' dollar which was held back by unsure investors prior to the Federal Reserves' announcement.

Look before leaping.

Top photo from here. 

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