For the second time in three months, world markets are braced for the beginning of the end of history’s greatest monetary experiment.
The Federal Reserve’s open market committee meets today to decide whether to start to taper the monthly $85 billion it spends on US bonds in the latest bout of quantitative easing.
The Fed sparked a day of volatility in September when it decided not to taper – billed in advance as “Septaper”. Now, share prices are falling amid speculation that the Fed will launch a “Dectaper” instead.
The process, dubbed “QE Infinity” has sparked a bull market in US stocks lasting almost five years. It has also enraged critics on the left and the right. It has not, as many predicted, stoked inflation. Five years ago, US consumer price inflation stood at 1.1 per cent.
Last month, it was 1.2 per cent. Share prices have risen almost directly in line with expansions in the Fed’s balance sheet, with the only major hiccups in the US stock market’s post-crisis rise coming when its bond purchases had been paused.
Underlying this, US firms have built profits largely through widening margins, while share prices have risen mostly through expanding the multiples investors pay for those earnings – rival returns from bonds are so low. Those reliant on cash have seen savings dwindle as interest rates are cut to zero. So left-wingers claim QE has stoked inequality.
Bankruptcies prevented
Meanwhile, it has saved many companies from bankruptcy, by making debt loads far cheaper to refinance. Despite a sluggish economy in which many companies would normally be driven to the wall, defaults on junk bonds ran at only 0.5 per cent last year. This compares to an average over history of 5.3 per cent. So critics on the right claim QE blunts "creative destruction".
A taper this month is not inevitable. While inflation remains so low, the Fed may wish to delay until March, to ensure the economy does not slip into deflation. But whenever it happens, the process of ending easy money has begun.
Ten-year treasury sovereign yields dropped to 1.39 per cent last year. They rose to 3 per cent in September, as the Fed talked up tapering, and have never reverted. They now trade at a yield of 2.86 per cent.
So what next? Central banks have greater knowledge about what happens when they pump so much money into the system. History is no guide to what happens when they stop.
– (Copyright The Financial Times Limited 2013)
