As I write this article, the US equity markets experienced their largest drop of 2013. The media reported that the cause was traders’ reaction to the release of the Federal Reserve meeting minutes. In the minutes, the central bank said that they may have to slow down or even end Quantitative Easing early.
If you are not familiar with the policy called Quantitative Easing (QE), it is a large purchase of US Bond by the Federal Reserve in an attempt to keep interest rates low. When bonds are in high demand and the price rises, it causes interest rates to drop. Lower rates make borrowing easier for businesses and should stimulate the economy.
Last month, the Fed Chairman, Ben Bernanke stated that the Fed was committed to the QE process and would continue to buy about $85 billion of bonds PER MONTH! In the latest minutes there was a concern about the costs of continuing the program. There is no wonder they are concerned, the current balance sheet of the FED exceeds $3 Trillion.
Back on September 25th, 2012, I wrote an article called “Insanity.” In the article, I discussed how the market rise from 2009 seemed to be caused largely from the Fed’s actions. When that government support appears to be slowing or stopping, traders are now seeing what it may mean for the markets.
In 2001, Japan started QE in an attempt to stimulate their slumping economy. Even with their efforts, Japan experienced three more recessions to date.
In 2006, Mark Spiegel, the Vice President of Economic Research at the Federal Reserve Bank of San Francisco, wrote a letter exploring whether the Bank of Japan’s QE worked. He stated that the program did benefit some weaker banks and also encouraged greater risk tolerance in the financial system. However, he also stated that the, “magnitudes of these impacts are still very uncertain.”
Flash forward to 2013 and the Yen is still incredibly weak and the stock market is still well below the high established after QE was adopted.
So what does this mean for the US? We may be abandoning our financial life support before it had a chance to work. That is if it even would have. Stay tuned, volatile markets are likely to come.