Yesterday morning NZ time saw the conclusion of the United States Federal Reserve’s (the ‘Fed’) latest meeting on monetary policy. While always a critical event in the global market calendar, this meeting was of particular importance as markets believed the Fed would announce a reduction in quantitative easing (QE), its $85 billion per month programme of bond buying.
As background, this programme is designed to help keep long-term interest rates low, in order to stimulate the US economy at a time when the official short-term interest rate has already been set to effectively zero for almost five years.
Contrary to expectations, the Fed announced that it would continue buying bonds at this massive rate of $85 billion per month. This rate of buying is now likely to continue into year-end, perhaps even into 2014. This also means that the conclusion of QE may well come later than the mid-2014 target that the Fed’s Chairman Ben Bernanke had previously indicated.
The exact profile of the wind-down of QE will depend on how the US economy performs over the months ahead. At present, it is growing at a moderate level, with GDP up 1.6% in the year to June, and the unemployment rate continuing to gradually improve, to 7.2% currently, from 10% in the depths of the crisis.
The Fed also made supportive noises regarding its ‘forward guidance’. This is the other aspect of its policy toolkit at present. It is based around providing explicit criteria to the market relating to how strong the economy needs to be (in regards to unemployment and inflation) before it would begin raising interest rates.
All of this represents a change of tack from what is the single most important policy institution for the global financial system.
Of course the crucial question is, what does this mean for markets?
The most important implications are that, firstly, US (and to an extent, global) interest rates are not going to be rising as quickly as many have feared. This helps company profits and supports the US consumer and housing market.
Secondly, partly because of the first point, equities are likely to remain the favoured destination for cashed-up investors over the coming quarter. At Milford, we continue to see a positive outlook ahead for shares both globally and in New Zealand. In our view, shares remain the best place to be invested currently, relative to low-yielding cash and bonds.
Thirdly, the US dollar becomes less attractive, at least in the short term. We are already seeing this, with the NZ dollar now buying 84 US cents, up from 77 cents just a few weeks ago.
The final point is that the Fed will still have to reduce its bond-buying in time. This is likely to come in December, we think, but only if the US economy gathers pace. If that is happening, we expect it will remain a reasonably supportive environment for shares, at least for a while yet.
David Lewis
Senior Investment Analyst