Cooling relief from the Fed's Aussie burn

The Federal Reserve's hint that it is starting to think about ending its quantitative easing program is a welcome development that could soon spell relief for the soaring Australian dollar.

In the immediate wake of the release of the December minutes of the US Federal Reserve Board’s Open Market Committee overnight the US dollar edged up and the Australian dollar edged down. While still distant, relief from the inexorable pressure the Fed’s policies have imposed on the Australian economy might be just over the horizon.

The Fed’s policies of quantitative easing – money printing – and near zero official interest rates have, by lowering the value of the US dollar, created immense pressures for the trade exposed sectors for the economy.

They have ravaged large segments of the manufacturing sector and played a major role in the blowouts in the cost of resources sector projects when expressed in the currency that matters to miners, the US dollar.

While the Fed’s policies are focused on trying to stimulate growth in an anaemic post-crisis US economy, it has effectively mounted an assault by the world’s reserve currency on the competitiveness of stronger economies.

It has also created incentives for a global search for yield and returns by US investors that has been distorting the normal risk-return appraisals and which has the potential for a host of unintended consequences, most obviously asset price bubbles.

Indeed, there has been considerable discussion about the impact on bonds markets – and the potential for something quite unpleasant – if and when the Fed does try to end the QE program that has expanded its own balance sheet by $US1.5 trillion and which, if its continues through 2013, will add another $US1 trillion or so.

Australia’s status as one of the strongest post-crisis economies and as a relatively safe way to get an indirect exposure to China and the growth economies in Asia because of the size of the resources sector has seen massive inflows of capital that has pushed the dollar to historically high levels. The Reserve Bank doesn’t have the resources or the inclination to intervene significantly.

That’s why even a hint that the Fed is starting to think about ending the program is a significant development and, from our perspective, a welcome one.

The minutes, while reconfirming the Fed’s commitment to the program, revealed some differences of opinion within the Open Market Committee about continuing with QE3 and the $US85 billion a month of mortgage and Treasury bond purchases it entails.

Some of the committee members are keen for the program to continue through 2013 but "several" want to slow or halt the purchases well before year-end and one member wanted the Fed to simply end the buying.

All the members, according to the minutes, are uncertain about the benefits and costs/risks of ongoing purchases and several are concerned about the size of the Fed’s balance sheet and its implications for financial stability.

Maintaining the program risks creating asset bubbles or swelling existing bubbles – the bond bubble, for instance – to the point where the eventual end to the program could destabilise the US, and perhaps global, financial system.

The Fed’s slightly more questioning stance on its QE program comes as there are some encourage, albeit modest, signs of life in the US economy.

The Fed has made it clear that US monetary policy will remain accommodating until there is a significant fall in unemployment. It has said it will maintain low rates until the unemployment rate, now just under 8 per cent, falls below 6.5 per cent – unless the inflation rate starts to rise which, given the extent of the money printing, one assumes it eventually will.

Ending the QE program later this year wouldn’t mean a change in the low US rate policies nor that the Fed would start selling the bonds it has accumulated on its balance sheet, simply that it would stop buying new securities. When that eventually starts happening we’ll be in unchartered territory.

For the moment, nothing much changes but the FOMC minutes do suggest that a measure of relief for currency-stressed economies might be, while not quite in sight, at least increasingly on the Fed’s agenda.


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