The gasp heard around the world Wednesday was the global financial markets reacting to the U.S. Federal Open Market Committee's decision not to taper off its $85 billion per month of asset purchases. Officially the reason for the delay in tapering was that the FOMC wanted to wait for more data to clarify the path of the recovery. This is particularly key in the light of the Fed's own estimates of GDP for 2013 and 2014, which got clipped by 0.3% to 2.2% and 3.0% respectively.
Unofficially, the Fed got spooked by the sudden rise in long term rates after its indications of tapering in June, although one major bank estimated that the rise in yields translated to only a 0.25% knock off GDP – hardly a reason to freak out that the U.S. economy was veering off course. Nevertheless, the Fed is concerned about rates and the potential for a fiscal showdown with the Congress and President over the few weeks.
Market reaction was quick and severe. Bond prices rose the most since November 2011, sending yields down 18 basis points by the close of trading Wednesday. The S&P 500 rallied to an all-time high. Gold rose and the U.S. dollar fell against virtually every currency in the world.
Taking a more global perspective though, this does bring the Fed in line with many of the other major central banks. The ECB and Bank of England effectively remain on hold when it comes to keeping interest rates low. The Bank of Japan is still on course to double its monetary base in two years.
Granted, this does also throw a lifeline to emerging markets. All summer long we have seen emerging markets take a pounding as capital shifted from those markets to what investors expected would be a higher interest rate environment in the U.S. That trend is reversing somewhat. Indonesian equities rose the most in almost two years, moving up 4.7% while Indian stocks are up 3.4%.
My view: This was another shot of morphine into a patient that needs to leave the hospital. The problem with this decision is twofold: First, it shows an incredible lack of confidence from the Fed that the U.S. can withstand market forces that naturally have been taking rates higher. Secondly it makes the eventual taper much harder in my view, as the Fed's credibility has been really damaged, and needs to be reestablished for markets to properly function and allocate capital to its best use. Short term it is good for stocks, bond prices and emerging markets, but is a poor prescription for the economy as a whole.
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