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Ending QE

QE is officially dead, but its ghost could linger

Some investors detect hawkish tone from Fed's rate-setting board, but fund managers defer

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The US Federal Reserve's quantitative easing programme is officially dead, but its ghost will continue to haunt the US stock market - at least until the Fed's next move becomes clear.

THE US Federal Reserve's quantitative easing programme is officially dead, but its ghost will continue to haunt the US stock market - at least until the Fed's next move becomes clear.

US stocks and bonds fell slightly on Wednesday after chairwoman Janet Yellen's Federal Reserve confirmed that its bond-buying exercise would be consigned to the crypt on Friday - Halloween.

For six years, the Fed's sorcery in the bond market had helped to keep mortgage and loan rates at historic lows. Now, the economy and stock market must contend with the ghouls of rising rates without Ben Bernanke or Janet Yellen's magic wand. For those who had expected a concession to the recent weakness in world markets and manufacturing data, the Fed's tone was frighteningly hawkish. While Ms Yellen's rate-setting board reiterated a promise to keep rates low for a "considerable time", the assessment of the economy was almost glowing.

"Labour market conditions improved somewhat further, with solid job gains and a lower unemployment rate," the central bank crowed. "On balance, a range of labour market indicators suggests that underutilisation of labour resources is gradually diminishing."

To many investors, that sounded a lot like laying the groundwork for an interest rate hike. The dollar gained in value against the euro, a bet that rates in the US will be higher than those in Europe where the central bank is still in rate-cutting mode. Traders sold out of gold, Treasurys, and high-risk small stocks - all popular investments throughout the years of the QE programme.

"People are jumpy right now, and they read into the Fed statement relating to strong employment growth and overall benign inflation environment thinking, 'hey, that means maybe they're going to raise sooner rather than later'," said Oliver Pursche, president of money manager Gary Goldberg Financial Services. "I don't think that's what they said at all; if you look at the whole statement, it's very much in line with what they've been saying: continued improvement with pockets of weakness . . . (and they) remain data driven."

The statement could not be considered purely hawkish - or leaning towards hiking interest rates - because the Fed said that there was nothing to fear from inflation, the motive for raising rates. Still, "investors are addicted to 'more dovish than expected'," or a lean towards cutting rates, said Lorenzo Di Mattia of hedge fund Sibilla Global Fund. The Fed pointedly left out any suggestion that stimulus could be reintroduced.

Much of the trading on Wall Street has become a handicapping game on when the Fed will raise rates. Some are betting that the central bank will be forced to come back with more bond buying; others bet that "considerable time" of low rates means a year or more; a third camp are betting that the rate hike will come as early as the first or second quarter of 2015.

St Louis Federal Reserve president James Bullard gave the first camp some hope in mid-October, when, during the wild trading in stock markets worldwide, he said that the Fed had cause to delay the end of quantitative easing. Those hopes were dashed on Wednesday.

One of the only gainers in the wake of the Fed's statement was the financial sector, which is the only line of business that benefits from higher borrowing rates.

Economists at Morgan Stanley recently noted that the divergent central bank policies and economic growth rates worldwide are further complicating the Fed's timing decision. They said in a research note that Ms Yellen's European counterpart, ECB president Mario Draghi, has asked her to share some of the US's domestic strength by tolerating an appreciating dollar vis-à-vis the euro, even as he stumbles along in the effort to provide more policy accommodation by his own central bank.

They said that the Fed was prepared to sacrifice the competitive advantage of a weak currency, in part because "Fed officials understand that, while the US can temporarily expand faster than its G-7 colleagues, the best contributor to sustained expansion at home is assured expansion abroad".

To one observer, when the Fed raises rates is not as important for the stock market outlook as why the central bank does so.

"If they raise rates because of jobs growth that's a big positive; if they raise rates because inflation is becoming an issue, that's a negative," said Mr Pursche of Gary Goldberg.

 

Ending QE