The headlines state that the Federal Reserve has reduced its asset purchase programme by a further $10 billion a month, but if you think about it, the real story is that the world’s largest economy still thinks that it needs to pump $55 billion per month into that economy. The reasons behind the asset purchase are that the central bank wants to provide liquidity to the financial sector and thereby encourage lending to businesses so as to stimulate growth and create jobs. Additionally, the programme aims to swap out higher interest bonds against cheaper bonds, thereby reducing the costs of servicing America’s rather substantial debt and to keep mortgage costs low, by creating a strong market for mortgage-backed securities. In normal times, none of this is needed, although the long term interest charge reduction has been a good idea for a long time now – but is driven by QE, of course, which would be regarded as a risk for hyperinflation against a normal background.
The reduction in US asset purchases caused global markets to wobble lower (it can hardly have come as a shock to any literate investor) and push the Dollar higher. The reason for the appreciation of the Greenback popularly cited in the press is that members of Fed’s monetary policy team have suggested that interest rates may rise as early as next year. Whilst return on forex holdings is a factor in larger, long-term strategies, many factors will move the markets between now and them – just look at current anxieties in the Ukraine, for instance. More likely, trading algorithms are tweaked to profit from longer-term uptick signals, pushing the currency up. Usually, the status quo ante has been restored within the space of a week, giving credence to this analysis.
As the tap of “cheap money” is being turned off, investors who placed funds in emerging markets, aiming at greater returns, tend to consolidate their gains and withdraw their assets, causing these markets to dip. Given that interest rates are at historic lows in many central banks, they only have one direction to go – it’s a question of when rates will rise, not if: that’s been true for a long time now.