The long expected and symbolically significant beginning of the end of quantitative easing by the Federal Reserve is now almost certainly upon us. Will it be it good news or bad news? QE was a highly drastic measure, only a depression of the enormity of this last one would have caused the US to throw what amounted to $85 billion a month for all these years into the financial markets. So, yes, it is a sign that the US now believe they are strong enough to stand on their own two feet without this artificially created flow of cheap, electronic money. The “tapering” is expected to start with a reduction in the purchase of government bonds by $10 to $15 billion a month. But will it be a “taper” which lights a torch of panic? All fx market traders will be waiting for the announcement and the tone it is delivered in, with baited breath.
QE3 was the third round of a monetary policy that came to define the aftermath of the global financial crisis. In many ways it was the only possible default policy with most governments either unwilling or unable to launch fiscal stimulus and short term interest rates stuck on zero. Private investors get less access to long term assets which have been bought up by the central bank, this drives up their price and thus longer term interest rates are driven down to stimulate the economy. Although the choice to taper is only really a small step, it means passing the point of “peak QE3″ and this could be enough in itself to cause turmoil.
As the intention to ease off has been widely forecast, the expectation is that the markets will not react much, speculation has been rife for many months and the markets are already adjusted. That said, a surprise decision not to taper at all would be a shock. Razor sharp scrutiny for fx market analysts over the next few days is going to be paramount.
What does it mean for Britain and Europe?
If no crash is triggered it will help cement the resolve not to do more QE in the UK. A healthier US is better for European exports and will lead to higher yields if the dollar increases against the euro, making European products cheaper. But if it pushes up borrowing costs this won’t help Spain and Italy.
Emerging fx markets have benefited under the tsunami of cheap money under QE and allowed them to flourish on cheap credit. If capital starts to pour out again of emerging markets and currencies it could have massive ramifications in Asia, Brazil and Indonesia. Central banks there have no choice but to shore up their currencies and have begun to do so.
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