The U.S. Federal Reserve will end its US$3-trillion quantitative easing (QE) program at its October Federal Open Market Committee (FOMC) meeting on October 29.
It’s a momentous occasion that truly marks the end of the Ben Bernanke era at the Fed; the former chair introduced QE in a bid to save the American economy from ruin in November 2008. It also indicates the Fed’s confidence in the state of the strengthening U.S. economy, but who’s to say the central bank won’t whip out this policy tool again should necessity demand it?
Last year, a mere statement from Bernanke about the Fed’s plans to reduce the amount of bond-buying drove markets into a tailspin. Emerging markets in particular absorbed huge losses after benefitting from global investors’ search for yield in a prolonged low-rate environment.
The actual start of tapering last December was not as influential, however, as it marked the beginning of a process that in the eyes of the market ends not with the end of QE, but an interest rate increase. During her first press conference following her first FOMC meeting, then newly elected Chair Janet Yellen made the rookie error of mentioning that rate hikes would begin six months after the end of tapering. Financial journalists in attendance at that event did quick math to figure out that QE would end this fall (and it is), which would take the Fed until spring 2015 before initiating a rate hike. Since then, the Fed has tried to distance itself from those comments by encouraging the market not to focus on the schedule, but rather on economic fundamentals, as they will dictate the schedule and not the other way around.
How Soon Is Now?
Overall, the Fed has done a poor job of communicating its intentions to the market these last few months. It further complicated its messaging via a series of conflicting Fed member statements. In its own official forecast, the Fed does not plan on a rate hike in the first half of 2015, yet its end-of-the-year forecast calls for an increase over the near-zero interest rates we have today.
This means the Fed has pushed back the start of the rate-hike cycle, potentially resulting in an accelerated rate of hikes. It is uncertain at this point which one will be more disruptive to the markets. The Fed wants to keep things calm but by its own actions it’s creating uncertainty and volatility, only to repeatedly dismiss committee members’ comments to curtail market panic.
This cycle of sustained low rates and stimulus has spurred global market indexes to break records while siphoning liquidity from other markets as investors pour into speculative investments with an attractive return. The Fed has strongly hinted that this era will end soon. How soon is now? The Fed can’t say because it all depends on the U.S. economy and how it will react to what the Fed does.
Global Inflation Worries Abound
Inflation stateside is weak and it remains a worrisome matter for the Fed but the U.S. in a much better place on that score than Europe and Japan. Europe is facing a very real threat of deflation similar to the one experienced in Japan in the now two “lost” decades.
Japanese Prime Minister Shinzo Abe pledged to end his country’s chronic low inflation which discourages consumers and subsequently gross domestic product growth by launching a three-pronged strategy dubbed ‘Abenomics.’ His three arrows were launched in early 2013 but only the first one — monetary stimulus by the Bank of Japan — has been truly effective. Europe faces a political quagmire in order to be able to launch similar stimulus.
The European Central Bank (ECB), meanwhile, has its hands tied as it’s looking for alternative ways to stimulate the ailing eurozone economy. Germany stands as the biggest roadblock to eurozone stimulus, as domestically it is not seen as the right solution, and it could result in political backlash if German funds are used to bail out other nations viewed as irresponsible.
An Uncertain Road Ahead
The Fed remains in the lead as the major central bank most likely to raise rates first. Previously, it was the Bank of England (BoE) the market largely expected to spike rates as the U.K.’s economic recovery outperformed earlier this year, hoodwinking the Old Lady’s own economists. That left the market wondering if the BoE was out of touch with its own economy. Governor Mark Carney changed his dovish tone to accommodate the improved economic weather only to watch it turn on him again as new warning signs threatened the trajectory of U.K. economic growth. The end result pushed expectations of a BoE rate hike well into 2015.
Analysts expect the Fed will stick to its script and announce an end to QE. The language from the statement will be the closely scrutinized as there will be no press conference from Yellen to give further insights. Though the U.S. economy has suffered minor setbacks like downbeat retail sales figures that shrank-0.3% in September, the market overreacted to the data with one of the worst selloffs in history. The global economy remains highly dependent on U.S. economic growth and any indicators that point to weakness will be more heavily penalized by markets as investors won’t hesitate to flock to safety.
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