As expected, the US Federal Reserve has voted to end its bond-buying stimulus program commonly known as QE3 and signalled to markets that it was not worried about global weakness, low inflation or the recent wobble in financial markets.
The move had been long expected, but will see a period of volatility in markets as investors adjust.
The most likely move will be to see a gradual rise in US bond yields and in the value of the US dollar, and weakness in commodities and in related currencies such as the Aussie and NZ dollars. Gold fell this morning by $US18 an ounce in US trading to end at $US1,211 and is looking to go lower.
But with the Bank of Japan on the cusp of perhaps upping its huge easing program and the European Central Bank making a modest start to its easing, there will be plenty of bumps in markets ahead in coming months.
But it does signal that the first rate rise in the US since 2006 is ahead of us – we just don’t know the timing and nor does the Fed at the moment.
The Fed’s decision ends three phases of QE over six years which have seen the central bank expand its balance sheet to around $US4.5 trillion in an unheralded series of policy moves which have sparked considerable debate, but helped steady the US economy to the point where it can grow without that considerable stimulus.
US unemployment has fallen sharply, the economy is growing at an annual rate of around 3% (as we should see tonight with the first estimate of third quarter GDP), the stockmarket has rebounded to a series of new highs for the Dow and the S&P 500.
It was a historic decision by the Fed which was taken in a vote of 9 to 1, with the lone holdout a governor considered to be a ‘dove’ and not one of the usual dissenting hardliners.
This third round of easing started in September of 2012 when it pledged to buy $US85 billion of long-term assets every month until there was a substantial improvement in the jobs market.
Since then, the unemployment rate has fallen from 8.1% to 5.9% and the pace of easing cut to just $US15 billion this month.
In the statement, the Fed left unchanged its pledge that rates would remain near zero for a “considerable time,” but that has been hedged around with a couple of important changes in language in the post-meeting statement.
The Fed kept its forecast of low interest rates for a “considerable time”, but explicitly tied the start of that period to this month, and inserted a get out clause to allow for earlier rate rises if the economy improves faster than expected.
“If incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated,” says the Fed statement.
“Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”
Those sentences are going to be the source of most future speculation about when the Fed will move rates, starting with the October jobs report a week Friday night, our time.
In a major change of language, the Fed’s Open Market Committee dropped its previous view that there was “significant underutilisation” of labour resources, saying instead that this was “gradually diminishing”.
That too will generate a wave of all knowing commentary from economists and other.
The Fed’s new assessment of inflationary risks suggests the central bank could hold off raising interest rates for the first time since 2006 even longer than investors expect.
The central bank dismissed concern with the recent drop in inflation expectations seen in financial markets,saying that surveys of longer-term inflation expectations have “remained stable.” It said that low inflation has been held down by low energy prices and “the likelihood of inflation running persistently below 2% has diminished somewhat since early this year.”
The bank stuck to language saying it could maintain fed funds at zero for a "considerable time" after the end of asset purchases to continue to support the economy. Most analysts have been predicting the bank would increase the key fed funds rate – now at zero – in mid-2015.
US shares sagged immediately after the statement, but that was to be expected, given the febrile nature of market confidence on the end of QE.
The Aussie dollar though lost its confidence from yesterday which saw it peak at 89.11 US cents and was trading nearly one and a quarter cents lower at 87.90. The local stockmarket will start trading flat this morning. Gold eased and oil edged higher.
The only member of the ten-member Open Market Committee dissented – Narayana Kocherlakota, the president of the Minneapolis Fed.
Two hardliners who had dissented in September – Richard Fisher of the Dallas Fed and Charles Plosser, the president of the Philadelphia Fed – supported the latest Fed statement.
