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For sizzling markets, questions loom as Fed edges back
September 19, 2017 / 2:09 PM / in a month

For sizzling markets, questions loom as Fed edges back

The seal for the Board of Governors of the Federal Reserve System is displayed in Washington, U.S., June 14, 2017. REUTERS/Joshua Roberts

NEW YORK (Reuters) - Financial markets sizzled over the last decade as the Federal Reserve injected $3.5 trillion (£2.59 trillion) in new money, with U.S. stocks far and away the biggest beneficiaries of a policy that may yet destabilize things as it is withdrawn over the years to come.

The Fed's unprecedented bond-buying was meant to stabilize the battered U.S. economy in the wake of the 2007-2009 recession. Yet the initial effects of monetary policy are on markets, where the S&P 500 .SPX equity index has nearly quadrupled since its crisis-era nadir in early 2009, logging a string of record highs.

The central bank on Tuesday begins a two-day policy meeting at which it is expected to decide to start shedding bonds in October. Advocates of the policy argue it helped cut unemployment by more than half. Detractors however warn it has inflated global asset prices in a way that could cause the next crisis, even while the stock-market bonanza has exacerbated wealth inequality in the United States.

The large-scale purchases of Treasury and mortgage bonds were aimed at encouraging risk-taking, including hiring by businesses and investing by individuals, which in turn was to boost economic growth.

As the Fed rolled out its three separate rounds of massive purchases, stocks shot up while the dollar sank alongside yields on U.S. debt. Each time these programs came to an end, albeit briefly, these assets retraced some of those steps.

The dollar index .DXY, one of the best early indicators of monetary policy decisions over the last decade, soared 27 percent from 2014 to 2016 as the Fed moved to finally lift interest rates from near zero in late 2015.

The Fed's plan to raise rates several more times in 2016 was scuttled by an unexpected slowdown overseas that year, prompting the yield on 10-year benchmark Treasury bonds to touch all-time lows as investors flooded into the perceived safety of U.S. debt.

The effects of investors rushing to and from safe investments has rippled well beyond U.S. borders.

When the world’s most influential central bank started ramping up its balance sheet and promising to keep U.S. rates near zero for long periods, investors hunting for higher-yielding assets flooded into emerging markets (EM) such as Turkey, Brazil and Indonesia.

The so-called "taper tantrum" of 2013, in which markets reacted abruptly to hints of the end of bond-buying, marked the reversal of that trade and hit EM currencies and stocks hard. This same "hot money" phenomenon boosted lower-quality U.S. corporate debt for a time.

 

Reporting by Jonathan Spicer; Editing by Dan Burns and Chizu Nomiyama

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