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A time to QE taper but not tighten

Harbour Asset Management gives its view on the US Federal Reserve's tapering announcement.

Thursday, December 19th 2013, 10:28AM

by Harbour Asset Management

The US Federal Reserve (Fed) has announced that it will taper its Quantitative Easing (QE) purchases from $85bn to $75bn a month. At the same time it has strengthened its guidance on overnight interest rates. Markets have breathed a sigh of relief.

Surveys ahead of the Fed's decision put the chances of a QE taper at 30-50%, with most seeing it as a close call. Much of the uncertainty surrounded the tactics of the decision: the role of chair soon moving from Bernanke to Yellen; thin December market conditions; and markets still nervous from the impact of the May-June taper talk.

In the end the Fed has rightly focused on the economic fundamentals and announced that:

“in light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases”. The Fed has not set a fix course for further tapering, which will be taken in measured steps based on the economic data.

The statement went to great lengths to emphasise that monetary conditions are still stimulatory (i.e. it is the stock of QE purchases not the flow that matters): “The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates”.

Importantly, the Fed has strengthened its forward guidance on overnight interest rates saying that: “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the 2 percent longer-run goal”.

With the offsetting effects from QE tapering and stronger forward guidance, foreign exchange and interest rates markets were little changed after the announcement. As such, in our opinion there are few implications for the RBNZ. They still look likely to be the first central bank to start tightening in 2014, and having to deal with the implications of an

elevated NZ dollar.

After becoming nervous about the chances of QE tapering in recent weeks, equity and commodity markets have breathed a sigh of relief on today’s news, with the S&P 500 up over 1.5% on the day. More generally, with this policy decision out of the way, markets can refocus on economic news and fundamentals.

There was also news overnight of stronger than expected German business confidence and lower than expected UK unemployment. Both serve as reminders that we are entering 2014 with an encouraging global macroeconomic backdrop. This is supprted by the annoncement that NZ GDP was 3.5% annual growth highlights the domestic economic momentum.

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