Despite a tumultuous week on markets, the Federal Reserve decided to continue to taper its asset purchasing program at their January 28-29 meeting. The end of chairman Ben Bernanke’s reign resulted in asset purchases falling another $US10 billion to $US65 billion per month.
Unlike its December meeting, there was little uncertainty surrounding whether the Fed would continue to taper. But the last week has provided some insight into the challenges faced by emerging economies as the Fed unwinds its unprecedented monetary stimulus.
Although the taper initially posed no problems when it began at the beginning of January – if anything, the response was favourable – the last week has been a challenging one for markets and emerging economies. It all came to a head yesterday when Turkey – at an emergency central bank meeting – raised its overnight lending rate by 425 basis points to stave off inflation and currency fears.
From February, the Fed will purchase $US30 billion per month in mortgage-backed securities (down from $US35 billion) and $US35 billion of longer-term Treasury securities (down from $US40 billion).
The Fed acknowledged that growth has picked up in recent quarters, noting that the unemployment rate is declining but still at an elevated level, while household spending and business investment has picked up.
Fiscal consolidation remains a mild restraining factor for the economy, although at President Barack Obama’s State of the Union address there was no emphasis placed on further debt reductions. Recent decisions by Congress suggest that austerity will be less of an issue in 2014.
The Fed reiterated that the taper is not on a preset course but remains data dependent. Based on current information and assuming the economy develops as the Fed expects, it anticipates reducing asset purchases further at coming meetings.
It also reiterated that policy will remain exceptionally loose until, at least, the time that the unemployment rate falls to 6.5 per cent, provided that inflation and inflation expectations remain well anchored. Based on these factors, the Fed believes that it will be able to keep the cash rate near 0 per cent well past the time that the unemployment rate falls below 6.5 per cent.
The Fed’s decision will surprise few. It was widely anticipated that the Fed would continue to reduce its asset purchases in measured steps. The process is likely to continue at its next meeting on March 18-19, but a lot could change between now and then.
The US economy does appear to have picked up in recent quarters (we will know for certain tomorrow when GDP is released) and projections for 2014 are generally fairly upbeat. But an inability to extend unemployment insurance for around 4 million people could slow the US economy significantly, and that may prompt a Fed rethink.
Market turbulence will continue to be a factor, with the currencies for a range of emerging economies getting hammered again overnight. Emerging economies will scramble to shore up their currencies and, like Turkey and now India and South Africa, they will move to increase their cash rates.
This will have obvious growth consequences. A slowdown appears certain in many emerging economies. Whether this will weigh on Fed decision-making is uncertain, but I’d wager that it won’t cause them much concern unless it feeds into US growth.
For Australia, further tapering will continue to keep our exchange rate lower, promoting export growth, but with the $US10 billion taper widely anticipated, the decision itself may have limited impact on the dollar. But with the taper likely to continue in March, Australian exporters should receive further relief over the next month.
On the downside, the Australian economy will prove to be more susceptible to slowing growth among emerging economies than the US economy, particularly if it spreads to south-east Asia. At the moment though, there remains considerable uncertainty in financial markets and it may take some time before markets sort themselves out.