Home news Banking sector in suspense over Fed's QE plans

Banking sector in suspense over Fed's QE plans

47
0

The world’s biggest and most important central bank is about to take a giant step into the unknown – and investors everywhere are agog.

The US Federal Reserve is tonight widely expected to confirm that it is to start unwinding the gigantic asset purchase scheme – Quantitative Easing in the jargon – that it put in place following the financial crisis.

Nine years ago, under its former chairman Ben Bernanke, the Fed began buying bonds in an attempt to drive economic activity in the US.
The idea was that, with interest rates cut to close to zero, more needed to be done to boost economic activity.
The scheme aimed to put money in the bank accounts of the previous holders of the assets being bought – banks, insurance companies, pension funds and so on – in the hope that money would be reinvested elsewhere in the economy to stimulate lending and investment.
The scheme saw the Fed’s balance sheet grow from around $800bn in mid-2008 to $2.1tn in June 2010.
In November that year, concerned the US economy was still not growing rapidly enough, the Fed launched another round of asset purchases that became known on Wall Street as ‘QE2′. This ran until the end of June 2011.
A third round of QE ran from September 2012 to October 2014. The upshot of all this is that the Fed has now accumulated $4.2tn worth of assets.
Now, with the US economy growing strongly and unemployment at exceptionally low levels, the time has come to unwind some of that purchases.

Image: US Fed chair Janet Yellen’s term in the post is up for renewal in February next year
This is a huge deal for the Fed. No central bank has ever sought to unwind asset purchases of this magnitude in the past and, if handled badly, the potential for turmoil, created by billions of dollars’ worth of bonds coming onto the market at the same time, is immense.
The markets reacted badly enough when, in 2013, the Fed indicated it would taper the size of its asset purchases. The subsequent fall in US Treasuries became known as the ‘taper tantrum’. So actually unwinding asset purchases is going to have to be carefully managed.

The likelihood is that the Fed will stop reinvesting its assets.
Until now, when a bond owned by the Fed matures and it receives payment from the issuer of that bond – the US Treasury – the Fed has been reinvesting the proceeds, keeping the overall scale of the asset purchases unchanged.
So it will initially start taking money off the table by not reinvesting money it receives when its existing bond holdings mature. This is expected to reduce the Fed’s balance sheet by around $10bn a month to begin with – but the sums involved are expected to increase to around $50bn a month in a year’s time.
In all, it means the Fed’s balance sheet will shrink by around $300bn during the next 12 months and by a further $500bn during the second year.
There could well be a real-world impact of all this, not just in terms of how markets respond, because other assets bought by the Fed under QE include mortgage-backed securities – which, as anyone familiar with the history of the financial crisis will remember, is a bond backed by mortgages on people’s homes or on commercial property.
These are riskier than US government bonds (or Treasuries, as they are known) but play a vital role in the real world because they enable lenders to package up risk and sell it on to others, in the process enabling homeowners to buy property.
The impact of the Fed unwinding its purchases of mortgage-backed bonds on the housing market is therefore going to be particularly sensitive if it pushes up interest rates – and therefore the cost of mortgages – for homeowners.
Watching all this with fascination will be other central banks around the world, including the European Central Bank, the Bank of Japan and the Bank of England.
All have embarked on asset purchases schemes of their own during the last decade – in the case of the ECB and the BoJ of a similar magnitude to the Fed’s – that, at some point, they too will presumably have to unwind.
This genuinely is something that has never been tried before on any meaningful scale.

Source: Sky News