Why the Fed Will Try to Calm Market Nerves
The U.S. Federal Reserve is likely to act soon to quell investor panic over the potential tapering of its bond-buying program, Fed watcher Jon Hilsenrath wrote in the Wall Street Journal late on Thursday.
Speculation over whether or not the Fed will pullback its $85 billion a month bond-buying program and the timing of that, has led to volatility in global markets, particularly within Asia. Japan's Nikkei, for example, has plunged near 20 percent from its five-and-a-half year high hit on May 23.
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The Fed meets next Tuesday and Wednesday and according to the Wall Street Journal article, Fed Chairman Ben Bernanke will use the opportunity to reiterate that there will be a considerable period of time between the end of quantitative easing (QE) and raising short-term rates, a point he made in March.
"The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed's broader commitment to keeping rates low," wrote Hilsenrath.
"This is exactly what the Fed doesn't want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward," he added.
According to Hilsenrath, whose reports on the U.S. central bank can be market moving, the Fed is now likely to take action to appease nervous investors in the coming months.
Following the onset of the global financial crisis, the U.S. central bank has launched three rounds of QE, the last being in September 2012. However, over the past few months' notes from the Federal Open Markets Committee (FOMC) meetings have shown that some members of the policy-making body are becoming nervous about keeping the QE program going for too long.
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Furthermore, the Fed has promised to keep short-term interest rates near zero until the jobless rate reaches 6.5 percent, as long as inflation does not accelerate. According to the Hilsenrath report, there is evidence that investors are panicking over a sooner-than-expected hike in interest rates as a result of the tapering off of QE. This is demonstrated by investors pricing in higher interest rates in their futures, forex and swaps trades.
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According to Kathy Lien, managing director of New York-based investment firm BK Asset Management, investors are not worried about rising interest rates, but are more focused on the prospect of QE tapering right now.
"Hilsenrath's article focuses on the discussion of interest rates. Everyone in the market realizes that when the Federal Reserve is going to do it [raise interest rates], they are going to do it very gradually," she said. "It's not going to be an abrupt series of interest rate hikes, unless of course inflation begins to sky rocket. They are not expected to do so until 2014 or 2015. We are talking about something that will happen a year and half from now," she said.
Lien expects June's update from the Federal Reserve to carry the same message as last month's minutes, which carried the tone of cautious optimism on the U.S. economic outlook.
"Bernanke is going to stick to the script. He is going to balance the conversation of tapering, which I still believe is gaining momentum inside the Fed, with an uneven outlook on the US economy. In the last month's FMOC meeting the Fed was still relatively optimistic, so I think there will be the same message in this meeting," she added.
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