Relief as markets take Fed’s move to end stimulus program in stride

­GLOBAL financial markets were relatively calm after the US Federal Reserve announced the end of US quantitative easing.

IN what may be a positive sign for the global economy, the much anticipated announcement of the end of US quantitative easing — where more than $US4.5 trillion has been pumped into financial markets over five years — was accompanied by relative calm in ­financial markets.

US bond yields rose slightly, the S&P 500 fell slightly and the US dollar saw modest gains against the major currencies. Most commodities apart from gold actually rose despite the stronger US dollar. The Australian dollar fell back below US88c after hitting a four-week high above US89c, and the benchmark S&P/ASX 200 yesterday rose 0.5 per cent to a five-week high.

The relative calm in financial markets was particularly encouraging because economists had ­expected the Federal Reserve’s October statement to indicate a greater willingness to keep interest rates low in response to recent volatility in global financial ­markets.

As it turned out, the Fed, under new chair Janet Yellen, was more positive on the US economy, saying “there has been a substantial improvement in the outlook for the labour market” and there was “sufficient underlying strength in the broader economy to support ongoing progress towards maximum employment in a context of price stability”.

The world’s most powerful central bank also reiterated that it would be appropriate to keep interest rates near zero for a “considerable time” after QE3 ends, and said US rate rises would now depend on upcoming economic data — if the economy improved it would lift rates earlier, and vice versa if the economy slipped.

“Although inflation in the near term will likely be held down by lower energy prices and other factors, the committee judges that the likelihood of inflation running persistently below 2 per cent has diminished somewhat since early this year,” the Fed statement added.

Unlike the first two rounds of QE, which had fixed end dates, the third round of money-printing and bond-buying was open-ended, and the Fed waited until the economy had significant momentum before gradually “tapering” its monthly bond-buying program from $US85 billion a month to zero.

After the end of “QE1” and “QE2”, global equities fell about 15 per cent and 20 per cent, respectively.

But global markets appeared more comfortable with the end of “QE3” — benchmark equity indices recently fell 10 per cent before recovering strongly.

As well as the “head of steam” in the US economy — the world’s main locomotive — investors have been reassured this year by further monetary stimulus in Japan and Europe to fight deflation and ­potential recession.

Japan is buying bonds at the rate of $US50bn a month and European Central Bank president Mario Draghi has talked about increasing the ECB’s balance sheet by €1 trillion ($1.4 trillion).

AMP Capital’s head of dynamic asset allocation Nader Naeimi said the end of QE in the US would not change his equity strategy, despite the increased volatility that followed the first two episodes. He still favours offshore equities, particularly in Europe. “Overall the US economy is on a much more solid footing this time,” he said.

“We have seen a big fall in inflation expectations in the past month, but I think a big part of that is due to the US dollar rise pushing commodity prices down. There are some concerns about Europe potentially going into recession, but lower commodity prices will help support economic growth.

“The biggest risk would come from inflationary pressures forcing the Fed to lift interest rates early, but there are currently enough disinflationary pressures to hold inflation down. Falling inflation expectations and the drag we are seeing from Europe are likely to have pushed back US rate hikes,” Mr Naeimi added.

In that regard, the interest rate projections of Federal Reserve members — the so-called “dot plot” — seem out of line with low and falling inflation expectations, and some downward movement in those projections is expected in December.

“There is a big disconnect between the dot plot and what the market is expecting and the Fed is saying for US interest rates,” Mr Naeimi said.

“Of course if they actually lower the dot plot too aggressively it could trigger fears about US economic growth.”

But while the Fed’s interest rate projections may be unrealistically high, and it may delay interest rate rises if the economy falters, investors were relieved that the bank did not see the need to hint at more quantitative easing in response to the recent market sell-off.

“I would actually have been more concerned if the Fed had said it will not end QE3 and might do QE4 — that would have indicated something is seriously wrong,” Mr Naeimi said.