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MRB's Insight of the Week: QE's end has been delayed not deferrred
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by Warren Smith on Sep 27, 2013 at 00:01
The US Fed decided on 18 September to continue its purchases of US Treasuries and mortgage bonds.
Concerns about a premature tightening in liquidity conditions had upset global bonds markets since May, and spread havoc in the emerging world, especially in those countries with current account deficits.
We expect investors to soon calm as they realise that the Fed is going to stay cautious, and any actual tightening in Fed policy will be a long way in the future.
A slowdown in Fed bond purchases is inevitable (and should start by the end of the year), which will mark the peak of the reflationary era.
However, the Fed’s balance sheet will still expand until at least mid-2014, underscoring that policy will remain very expansionary. Moreover, by tying future rate hikes to employment conditions, the Fed signalled that it will lag the business cycle and stay accommodative for a long time.
Monetary policy in the major countries has been abnormally pro-growth.
For instance, despite the most anaemic economic recovery in the post-WWII period, the gap between nominal GDP growth and policy rates in the G7 countries is at its most positive level in many decades, excluding a brief period when growth rebounded after the recession in 2009-2010. Meaningful growth slowdowns and recessions occur whenever the gap has been depressed or has fallen rapidly.
Fears that the Fed could lose ‘control’ of the bond market because of a dearth of buyers, thereby causing bond yields to soar further, are overblown (such sentiment typically develops during bond bear markets).
Importantly, the moderate pace of economic growth and continued below-target inflation are consistent with only a mild uptrend in bond yields now that the period of extreme bond overvaluation is over.