The United States Federal Reserve did not begin its anticipated “tiptoe” out of quantitative easing this week.
This was despite market expectations that the bank would begin reining in the stimulus programme, and herald the beginning of a shift from very loose to a more orthodox monetary policy regime.
In a statement released on Wednesday the Federal Open Market Committee, led by Ben Bernanke, said it had decided “to continue purchasing additional agency mortgage-backed securities at a pace of $40-billion per month and longer-term treasury securities at a pace of $45-billion per month”.
Bernanke had hinted in June that the US central bank could begin tapering its quantitative easing programme later this year, provided the underlying economic data pointed to a sustained recovery in the US economy.
The US central bank has been keeping interest rates at historic lows, coupled with quantitative easing — the monthly purchase of $85-billion in government debt and mortgage backed securities, increasing liquidity in a bid to spur investment and spending in the economy to help it pull out of recession.
The committee said it had seen “the improvement in economic activity and labour market conditions since it began its asset purchase programme a year ago as consistent with growing underlying strength in the broader economy”.
Awaiting more evidence
Nevertheless it “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases”.
The “tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market,” the committee noted.
Asset purchases were not on a “pre-set course”, Bernanke said in a press conference, they were entirely “conditional on the data”, notably the steady declines in the US unemployment rate.
The committee also noted that it would keep the target range for the federal funds rate — its equivalent of South Africa’s repo rate — at 0% to 0.25%.
The Fed would also continue to reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities back into these assets, and of rolling over maturing treasury securities at auction.
Markets had expected that the US central bank would begin to reduce its asset purchases by between $10-billion and $15-billion dollars.
Delaying the exit
Wednesday’s announcement will delay, by at least a few months, the start of an exit from the unconventional monetary policy that has been implemented, particularly in developed nations, over the past five years, and had extensive effects on the financial market around the world.
Alongside the US, other developed market central banks like the Bank of Japan have instituted similar quantitative easing measures.
But the excess liquidity created by this supportive monetary policy has seen large capital flows move into riskier emerging markets assets such as bonds and equities, as investors seek better yield.
The increased appetite for risk has been good for some nations, including South Africa, helping governments to keep their borrowing costs low, strengthening emerging-market currencies and buoying their stock markets.
These flows have helped South Africa to finance the perennial deficit on its current account. But the reliance on these portfolio inflows has left South Africa’s economy vulnerable to their slowing or reversal.
Following earlier hints in June that the US would begin to taper quantitative easing within the year, emerging markets roiled as investors began to reappraise emerging markets assets, resulting in painful falls in the currencies of many developing nations, including the rand.
Emerging-market currencies rise
Following this initial fallout, financial markets had, however, according to a number of local economists, largely priced in the impact of quantitative easing tapering in the runup to Wednesday’s announcement. After the Fed’s announcement Bloomberg reported that emerging-market currencies — the Brazilian real, the Indian rupee and the rand — all rallied against the dollar.
The unprecedented scale of these measures and the consequences that they have had on countries in the developing world has brought the matter to the fore in international co-operation forums, notably the G20.
The decision not to taper yet could raise questions about the path of the US economic recovery, Stanlib economist Kevin Lings said.
The eventual exit of quantitative easing, however, and the return to a more normal monetary policy regime, is something the Fed will “tiptoe” out of, and it is a process that will take years, he said.
Investment decisions would have to return to drivers such as economic fundamentals rather than the hunt for yield, said Lings.
South Africa has so far been “flattered by the yield hunt”, but this is likely to change in the future, he said.
South Africa is “doing less well” in terms of its fundamentals. Economic growth prospects were revised downward to 2% of gross domestic product (GDP) by the Reserve Bank, the government’s budget deficit widened to 5.2% of GDP, and employment remains at very high levels.
Large impediments to economic growth remain, including poor education outcomes, skills shortages, a labour regime that is deemed to be too rigid, as well as high levels of industrial strike action and infrastructure bottlenecks.