QE3 and tapering issues not settled yet
WORRY over the partial US government shutdown may be dominating current headlines but investors would do well to study the implications of a development that immediately preceded the shutdown, namely the US Federal Reserve's surprise decision not to taper its US$85 billion per month QE3 (third round of quantitative easing) monetary stimulus programme at its Federal Open Market Committee meeting a fortnight ago.
After an initial knee-jerk rally following that meeting, stock markets have floundered, partly weighed down by the political standoff in Washington but possibly also because of the signal sent by the Fed, namely that after five years of relentless quantitative easing (QE) the US economy may not be growing.
Two related observations are possible. First is the effectiveness of the Fed's communication policy. In recent years, the Ben Bernanke Fed has made it a practice to provide as much "forward guidance" to the market as it can, in the hope that adding certainty on interest rates and monetary policy props up Wall Street and creates a "wealth effect" that feeds through to consumers, encourages them to spend more and so helps the economy to recover. This in turn has placed investors everywhere on near-permanent Fed watch, sending prices up and down in tandem with every release of US economic data and regular utterances by Fed governors. At some level, this approach has been effective - since the sub-prime crisis erupted in 2008, Wall Street has more than doubled to an all-time high. However, because the Fed had in May led the market to believe that tapering would commence soon, the decision last month not to taper has now created confusion and added uncertainty. Analysts who had grown over-reliant on forward guidance are now not sure when tapering will start - if at all.
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