No easing of pressure on Aussie
Until yesterday the Fed was promising to maintain what is effectively a 0 per cent cash rate until at least the middle of 2015. It also had a third leg of quantitative easing under way, in the form of monthly $US40 billion purchases of mortgage-backed securities using freshly printed money and monthly purchases of another $US45 billion of long-term US government debt with funds freed up by liquidation of its holdings of short-term US government paper.
Its stocks of short-term debt have been cleaned out so it will now print another $US45 billion every month to keep its long term bond-buying operation alive, taking its QE commitment to $US85 billion a month.
It has also replaced its promise to not raise interest rates until at least the middle of 2015 with a new commitment to run both low rates and QE for as long as the US unemployment rate stays above 6.5 per cent.
This is the first time a big central bank has openly targeted a specific unemployment rate and it remains to be seen whether it extends or truncates QE.
What is certain is that QE is going to run for an extended period.
The US unemployment rate peaked at 10 per cent in October 2009 and has declined from 8.3 per cent to 7.7 per cent so far this year.
If it continues to fall at this year’s pace and inflation does not get out of control, the Fed could inject $US85 billion a month into the system for about 22 months — $US1.87 trillion — before unemployment reaches 6.5 per cent. The programme could be even bigger, however.
The Fed held between $US700 billion and $US800 billion of government debt when it launched its first QE programme at the end of 2008 and now holds almost $US2.9 trillion of government debt, bank debt and high-grade securitised residential mortgage debt.
A double-barrel programme that ran for 22 months could boost its balance sheet to about $US4.8 trillion — but it is possible that unemployment will take more than 22 months to get to 6.5 per cent, keeping the Fed in the market for longer.
That’s because the fall in US unemployment owes more to Americans giving up their search for jobs than it does to outright job creation: 60 per cent of the fall since October 2009 is due to lower workforce participation. If participation rises again, unemployment will fall more slowly.
Bernanke has changed the settings a bit. What was once thought likely to become ‘‘QE Infinity’’, Bernanke’s version of European Central Bank boss Mario Draghi’s promise in July to do ‘‘whatever it takes’’, is now QE3+ – a program with no fixed end date but a clear target that will eventually be met.
That target is far enough away to guarantee that QE3+ will be massive and will combine with low rates in the US and Europe to keep upward pressure on the $A.
The Reserve Bank of Australia has cut its own cash rate by 1.75 percentage points in 13 months to 3 per cent but 3 per cent is solid gold for global investors when northern hemisphere rates are so low that some central banks are charging investors to take deposits.
Quantitative easing itself, meanwhile, works to reduce mortgage and other long-term debt rates in the US, giving investors another reason to look at Australian fixed interest offerings, and bid up the Aussie if they decide to buy in.
As the Fed funds QE3+ by printing money, it is also debasing the currency and improving the US economy’s international competitiveness. When there’s more greenbacks in circulation the value of each of them declines — and the dollar’s ascent since the global crisis reflects the greenback’s fall as well as buying of the Aussie as export income is repatriated and as overseas investors chase our attractive interest rates.
Currency depreciation has been a zero-sum strategy for US-European exchange rates. The euro has falling at much the same pace as the US dollar since Bernanke began his first round of quantitative easing late in 2008.
Both currencies have fallen heavily against other currencies including our relatively high yielding dollar. The $A has averaged about $US1.03 this year, and has appreciated by about 5 per cent to about $US1.05 – but it has risen by 69 per cent since Bernanke launched QE1 in 2008. On the other side, the US dollar has fallen by almost 40 per cent against the $A.
Australian dollar euro rates are also not much changed this year. A euro bought about $1.23 yesterday, and the average for the year is the same. The $A is up 62 per cent against the euro since late 2008 however, and the euro is down against the $A by 38 per cent.
The Reserve Bank is acutely aware of all this. Reserve bank governor Glenn Stevens noted on Wednesday in a speech to Bank of Thailand that balance sheet expansion by central banks created ‘‘spillovers’’ into other economies and currencies and the ‘‘degree of disquiet’ was rising.
Central banks needed to ‘‘continue to talk frankly with each other about how we perceive the interconnections of global finance to be operating, ‘‘ he said.
That sounded like a call on the official family and the Fed in particular to more candidly discuss the pressure QE and zero rates are creating in countries like Australia.
The Reserve will probably cut its cash rate again early in the new year. It knows however that the impact of rate cuts on the value of the $A will be offset to an extent by quantitative easing in the US and elsewhere until QE ends.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
Ben Bernanke expanded QE — dubbed QE3+ — by committing to large monthly asset purchases and explicitly tying the policy to the US unemployment rate. The Fed is buying about US$85 billion a month and said it will keep rates low and run QE while unemployment stays above 6.5%, marking the first time a major central bank has targeted a specific unemployment rate.
If unemployment falls at the current pace and inflation stays contained, the Fed could inject about US$85 billion a month for roughly 22 months (about US$1.87 trillion). The Fed’s balance sheet could grow from roughly US$2.9 trillion toward about US$4.8 trillion under a double‑barrel program, though QE could run longer if unemployment falls more slowly.
QE3+ and persistently low rates in the US and Europe put upward pressure on the Australian dollar. With US long‑term yields depressed by QE and Australia offering relatively higher rates, overseas investors may buy Australian fixed income and the AUD, pushing the currency higher.
QE reduces US mortgage and long‑term debt rates by buying securities, which lowers returns in the US. That encourages investors to seek higher yields elsewhere — including Australian fixed interest — increasing demand for Australian bonds and the AUD.
Since QE1 in late 2008 the Australian dollar has strengthened significantly: the AUD has risen about 69% against the US dollar and about 62% against the euro. This year the AUD averaged roughly US$1.03 and was around US$1.05 in the recent snapshot; the US dollar has fallen nearly 40% versus the AUD since QE1.
The RBA cut its cash rate by 1.75 percentage points over 13 months to 3%. The article says the Reserve will probably cut its cash rate again early in the new year, but any downward pressure on the AUD from RBA cuts will be partly offset by QE and low rates in the US and elsewhere.
Much of the fall in US unemployment since October 2009 reflects lower workforce participation rather than pure job creation — about 60% of the decline is due to weaker participation. If participation rises, unemployment could fall more slowly, lengthening QE’s duration.
Everyday investors should monitor the Fed’s unemployment threshold and QE announcements, RBA cash rate moves, yield differentials between Australia and major economies, and central bank commentary about international spillovers (as highlighted by RBA governor Glenn Stevens). These factors affect currency moves, bond yields and the attractiveness of Australian fixed income.
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