What do the actions of the Federal Reserve mean for me?
In the aftermath of the financial crisis, central banks (the Federal Reserve, the Bank of England, the ECB) decided that the only way to save their precarious economies was to drop interest rates and launch ‘quantitative easing’ (QE), a complex way of getting money to circulate round the financial system better and to encourage banks to lend.
The US was the first to try it and now, almost a decade later, it is withdrawing it. The Fed also said it anticipated raising rates three times in 2018.
Why has it happened?
This policy came in response to a potential crisis in the financial system. The US economy has now recovered and is showing good growth. The Fed no longer believes that it is appropriate to have ‘crisis’ measures in place.
Why does it matter for me?
It will have an impact on all markets, both stock markets and bond markets. The Fed is effectively taking money out of the system, which means there is less money supporting asset prices. This is particularly true for bonds. Central banks have bought bonds as part of the QE programme and its withdrawal means fewer buyers for bonds. This could see prices fall.
Adrian Lowcock, investment director at Architas, said: “The significance of the announcement, whilst expected, should not be under appreciated. This is a once in a generation change. Over the past decade we have become used to central banks buying bonds each and every day. That has now changed and when the programme gets up to speed the Fed will be reducing its balance sheet by $600bn a year. This matters to investors in bonds as it affects how you invest in them and the returns you can expect to get from that asset class in the future.”
It also makes it more likely that the Bank of England and ECB will either put up interest rates, or withdraw their QE programmes. Unigestion investment manager, Olivier Marciot, said: “We believe this paves the way for other central banks to reduce QE where it is still alive and tighten monetary support slowly but surely. The Bank of Canada and the Bank of England have been surprisingly hawkish recently and the ECB is expected to taper its asset purchase program very soon.”
Could it cause a recession?
Probably not. The Fed is alert to any signs of deterioration in the economy. Nicholas Wall, portfolio manager, Old Mutual Strategic Absolute Return Bond fund, said: “Household balance sheets, in aggregate, look healthy, debt service costs are low and employment is high. The bigger risk is likely to be in asset markets.
“However, the Fed entrance and exit policies will be asymmetric in nature. On the way in, the Fed’s policy was shock and awe as it sought to stave off Great Depression 2.0. On the way out, it wants to be predictable and patient so as not to disrupt markets.
“Therefore, while inflation stays at a low level, the Fed has the luxury of being patient, as with most developed market central banks. Should inflation rise and central banks are inclined to act more quickly, then a buoyant market may face a bigger test.”
Any dramatic action required?
For the time being, markets are taking it in their stride. The FTSE 100 is largely flat on the day and currency markets appear largely untroubled as well. As you were.