The Nation



Financial war looms as the Fed tapers QE

The news conference of Federal Reserve Chairman Ben Bernanke appears on a television screen at a trading post on the floor of the New York Stock Exchange, Wednesday.//AP

The news conference of Federal Reserve Chairman Ben Bernanke appears on a television screen at a trading post on the floor of the New York Stock Exchange, Wednesday.//AP

The US Federal Reserve surprised the financial markets on Wednesday by announcing a tapering of its quantitative easing (QE). It looked more like a face-saving exercise for Ben Bernanke, who is scheduled to leave office as Fed chairman in January 2014.

He launched QE five years ago to combat the financial crisis by expanding the Fed's balance sheet from $800,000 million to almost $3.9 trillion (Bt126.4 trillion) now. So before he leaves his high office, the Fed must demonstrate it has reached the peak of its monetary trick and is about to wind down its money-printing programme. The baton will be passed to Janet Yellen, the first female Fed chief, in what the central bank hopes will be a smooth transition to impress the financial markets.

Starting in January, the Fed will cut back its asset purchase programme by $10 billion per month. This will leave the Fed's QE to purchase $40 billion in US Treasuries and $35 billion in mortgage-backed securities. A PR blitz to give the impression that the US economy is in recovery has set the stage for the Fed to launch the taper. Unemployment suddenly improved to 7 per cent in November, compared with 7.3 per cent in October, although there was no accompanying improvement in the economic fundamentals. Deutsche Bank said the Fed could end its asset purchase programme in October 2014. By that time, the Fed's balance sheet will reach close to a staggering $5 trillion. Still, the Fed will maintain its zero interest rate policy for the best part of two years, until 2015.

There were widespread expectations that Bernanke would taper the QE earlier, in October. But the conflict between Republicans lawmakers and the White House over the budget and the debt ceiling led the Fed to decide to keep QE intact. Now, as QE heads towards its sixth year, the indications to markets are that the Fed has reached its monetary objective and that 2014 will mark the beginning of a consolidation.

However, mathematically speaking, the Fed can't end QE. The US debt has reached $17 trillion. This year alone, the US Treasury must pay $7 trillion to refinance its debt. To keep the country's fiscal position going, the Treasury must continue to create more debt to repay the old debt, because tax revenues aren't enough to cover the debt. With buyers shying away from the US government bond market, there is only one major taker - the Fed, which now acts as the buyer of last resort for the US Treasuries. If the debt load keeps on expanding, QE will in fact have to be expanded rather than contracted. But the Fed, under Yellen, will find an excuse to continue or to expand the QE programme indefinitely. This does not bode well for the dollar.

In the short term, the Fed taper will hit emerging markets. Countries with large current account deficits such as India and Indonesia will be hardest hit, as capital flows out of the bond market and equity market. This will drive up interest rates. Emerging-market countries with huge debt loads and current account deficits will certainly see a hammering of their currencies. Thailand will not be immune to the volatile capital movements ahead. Already, foreign funds have been net sellers of Thai stocks to the tune of Bt190 trillion this year. The baht has also weakened to Bt32.40 in reaction to the Fed taper, which will also drive up the yields of US Treasuries. We are going to see a year of a full-fledged financial war as we move into 2014. So we better be prepared.

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