US Fed backtracks on end to QE

The US Federal Reserve surprised markets last night by backtracking on its suggestion in May this year that it would begin to “taper” quantitative easing from this month.

US Fed backtracks on end to QE

Instead of winding down its asset purchase programme as previously indicated, Fed chairman Ben Bernanke said weaker than expected unemployment data had prompted the decision to delay tapering.

It also announced a cut to its growth forecast sending the US dollar down sharply after the announcement with sterling rising above $1.60 for the first time since January.

“The dollar’s plunge comes at a time when the Federal Reserve’s decision to continue adding monetary stimulus puts it in direct contrast with the UK central bank, which increasingly looks to have finished its own quantitative easing policies in response to growing evidence of a strengthening UK recovery,” said Chris Saint, head of currency dealing at Hargreaves Lansdown.

Asian stock markets and currencies meanwhile rose strongly overnight – a signal of relief that monetary stimulus is here for a bit longer.

Dominic Rossi, head of global CIO of equities at Fidelity Worldwide Investment, said the reversal was a sign the Fed acted “prematurely” in May when it indicated to the markets that tapering would start.

“This underscores the dangers of forward guidance as a policy tool. The Fed will need to spend the next few weeks clearing up the message it wishes to send to the markets. This is not ideal as we await the nomination of the next Fed chairman,” he said.

“With that said, there are sound economic reasons why the Fed has maintained its policy stance. There are no signs of rising inflationary expectations after five years of quantitative easing and nominal growth remains remarkably low at 3%. The rise in long rates over the summer highlights the sensitivity of bond markets to tapering, and this both surprised and unnerved the Fed.”

Rossi justified the market’s “knee jerk reaction” to the announcement with the dollar weakening, equity markets soaring and commodities also being boosted.

And he added: “We see the Fed’s stance as bullish for equities in general, but mainly for developed markets over emerging markets, particularly as structural issues remain in the latter that show no signs of going away.

“We remain bullish on US equities above all and see weakness in the dollar as a buying opportunity. Improvements in fiscal and trade positions continue and the Fed will eventually start tapering at some point. I would sell gold into this strength and commodities generally.”

Private investors

But Patrick Connolly, a certified financial planner at Chase de Vere, warned that investors must be wary of being overly influenced by the knee jerk reaction of markets, especially as these latest comments simply delay rather than change a particular course of action.

“The US authorities will continue to operate accommodative fiscal policies and take the ongoing steps they consider necessary to support their economy. However, at some point their QE programme will need to be reduced and then stopped,” said Connolly.

“When this happens the markets are likely to react with stocks, bonds, gold and commodities falling and the US dollar strengthening. When QE is finally tapered, it will be because the US believes its economy is in a stronger and more robust shape. While equities might fall initially, if the US and other economies perform well we should then see share prices rebound, particularly for those well run companies which continue to grow and make profits.”

The longer-term story isn’t quite so positive for fixed interest.

Connolly said while a continuation of QE will support prices, yields on many assets are being held at artificially low levels and at some point are likely to revert somewhere back towards their norm, having a negative effect on prices.

And he added: “Rather than making tactical decisions based on what might happen, the best approach for investors is to hold a diversified portfolio consisting of cash, equities, fixed interest and property for the long term and not be distracted by short term market sentiment or noise.”

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