Posts Tagged ‘US Federal Reserve’

In recent weeks, the US Federal Reserve has dropped hints about the imminent end of its quantitative easing programme. At the same time, the Bank of Japan has announced a new, highly expansionary monetary policy, and even at the Bank of England many members, including its Governor Mervyn King, have voted for additional QE for much of this year.

This has created contradictory forces: speculation about the end of QE from the US, but expectations of more in the UK and Japan.

The US economy, however, is more important to the global economy than that of the UK and Japan combined, and in recent weeks markets have allowed their fears about the possible end of QE in the US to outweigh their hopes for more QE from other parts of the world.

In theory QE has the effect of pushing up the price of certain bonds, which in turn makes other assets look relatively cheap. Many argue that QE is the main reason for recent rises in share prices, and that it is therefore creating a bubble which will eventually burst.

On the other hand if the markets reason that QE will lead to inflation, they are likely to demand higher yields on bonds which will force their price downwards, so it is not clear that QE will always lead to higher bond prices. As for equities, it is worth noting that while valuations in equities to earnings may be marginally higher than long term averages, the ratio is not at levels that would normally be considered characteristic of a bubble.

So the jury is out on the overall effect of QE on bond prices and, more specifically, on equities.

However in recent weeks, the price on UK ten year government bonds has risen above the price of the US equivalent, suggesting that markets are selling US bonds in anticipation of the end of QE. They are not selling UK bonds in such large quantities because of hopes that the Bank of England may yet announce more QE. This may lend evidence to the idea that QE does indeed boost bond prices.

But the question remains: what will happen when QE finally comes to an end, whether this is in 2013, 2014, 2015, or at a later date?

When the US Federal Reserve increased interest rates in 1994, the eventual result was the Asian crisis of 1997, the Russian crisis of 1998 and the collapse of LTCM. The US, on the other hand, was largely unscathed.

If QE in the US is coming to an end, what does that mean for the rest of the world? Read the rest of today’s articles for an answer.

The end of QE: Canada and Australia 

The end of QE and the BRICs 

Beyond the BRICs: which emerging markets are vulnerable to the end of QE? 

© Investment & Business News 2013

10CC had the right sentiments; you just need to swap the word cricket for QE. “I don’t like QE, oh no, I love it”, or so they might have sung. “I was walking down the street,” said the Brazilian Finance Minister, “I heard this dark voice behind me, and I looked around in a state of fright…” But when he turned around he did not see “four faces, one mad; a brother from the gutter”, instead he saw Ben Bernanke and Mervyn King: “They turned to each other.”

“They looked him up and down and”, alas, that is where the rhyme stops. “We need quantitative easing, man,” they said. And they then did, they made it, money from the gutter flowed across the world.

The Brazilian Finance Minister called foul; he called it a currency war.

It is not like that now. As the Fed hints that QE may be coming to an end, as good news on the US and UK economy erupts from the bellies of Purchasing Managers Indices, markets fear what will happen if the era of cheap money, or magic money created from the dust, comes to an end.

The FT quoted Marcelo Salomon, an economist at Barclays, who said, “The [Brazilian] government is getting concerned that global liquidity conditions are changing really fast and that this could push the real to a much weaker level.”

So what to do? First off, Brazil has cut its equivalent of a financial transactions tax, which is to say its tax on overseas investment and which is called IOF, from 6 per cent to zero.

Brazil’s Finance Minister, Guido Mantega said, “With the market normalising and the movement of the [US] Federal Reserve to reduce its expansionist policies, we were able to remove this barrier.” But the FT sees the move as more dramatic than that and said that the Brazilian government feared a weakening currency could spark off inflation.

Indeed,  US QE may have been good for Brazil because it kept Brazilian inflation in check.  For that matter, in as much as QE led to higher commodity prices, and Brazil exports commodities, QE may have been very good for Brazil.

Maybe it is time Brazil’s Finance Minister comes clean by admitting, “I don’t like QE, oh no, I love it.”

© Investment & Business News 2013