Fed’s grand experiment draws to a close 

A grand experiment in US monetary policy is coming to an end. When the Federal Reserve releases the statement from its October meeting on Wednesday afternoon, the moment is almost certain to mark the end of the liquidity and stimulus programme known as quantitative easing.

Investors are already prepared for the Fed’s last $15bn of monthly bond purchases to cease. Now, they are betting that it will replace its extraordinary actions with soothing words to limit the volatility markets have seen earlier this month.

The hope is for language that suggests any tightening of monetary policy remains a story for the latter half of 2015, defusing any return of that kind of market turmoil.

In mid-October the S&P 500 briefly erased all of its gains for 2014 and Treasury yields plunged.

The question facing investors after nearly six years of large scale bond purchases that have swollen the Fed’s balance sheet to $4.45tn, is whether the US economy can prosper sufficiently to justify the large appreciation seen in asset prices.

As the curtain closes on the Fed’s third instalment of quantitative easing – QE3 – this month’s market turmoil provides a glimpse of what may lie ahead for investors with the central bank no longer pumping liquidity into the financial system.

“With domestic economic growth momentum beginning to leak lower, and the medium term outlook for the recovery and inflation becoming less certain, we expect the statement to be tweaked sufficiently to reflect a more dovish bias towards the near term monetary policy stance,” said Millan Mulraine, strategist at TD Securities.

Within the Fed, however, there are policy officials who believe interest rates should start to rise relatively quickly once QE ends – and that could open the possibility of a less dovish statement.

Another factor supporting asset prices as the Fed ends QE comes from other central banks borrowing from the Fed’s playbook. The Bank of Japan continues ramping up its bond-buying programme, as speculation rises that the European Central Bank will follow suit.

 

Source: FT- Fed’s grand experiment draws to a close

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