Friday, 20 December 2013
All year the Federal Reserve has been buying $85bn of assets with newly "printed" funds. In May the Fed's chairman, Ben Bernanke, first shocked the market with the news that this unprecedented level of support would have to be withdrawn at some stage. He went on to say that the withdrawal would probably start this year and be completed by the middle of next year.
Despite this guidance, forecasters generally predicted the first "tapering" of asset purchases would occur in March - they had been chastened by the mistakenly predicting the first taper in September. But since then economic news has been strong. Payroll growth, in particular, has been running at close to 200,000 new jobs per month. Four weeks ago, therefore, we began talking about the prospects of asset purchases being tapered in December in the seventh edition of the Brewin Dolphin podcast (available in our archive).
At the same time we observed that the market was beginning to react positively towards good economic news - an improvement on the conditions which had prevailed throughout much of the year when investors would cheer bad news and the enduring monetary stimulus it implies.
This week the Federal Reserve did indeed taper its rate of asset purchases by $10bn per month. The $10bn is comprised equally of Treasuries and mortgage backed securities (MBS) and leaves the Fed buying $40bn of treasuries and $35bn of MBS despite Fed research which shows that Treasury purchases provide little benefit to the economy. So why isn't the Fed winding up Treasury purchases faster than MBS purchases? Because they are running out of MBS to buy. Issuance has fallen following the rise in MBS yields after Bernanke first discussed tapering. That said, Treasuries are in a similar position. The twelve month average budget deficit was $88bn at the start of this year. Now it has fallen to $51bn. Falling issuance is just one factor supporting a wind up of these programs.
Contrary to the predictions of market collapse without the Fed's support, developed market equity investors have cheered the decision - the reaction has been more mixed in the emerging world. Ben Bernanke guided the market to expect similar sized tapers at future meetings, creating an expectation that the quantitative easing will only end in October. We would expect the Fed to start accelerating its tapering efforts by March.