At the latest Federal Open Market Committee (FOMC) meeting last week, the US Federal Reserve unexpectedly announced it would maintain its entire third-round quantitative easing (QE) measures, including its US$85 billion monthly bond-buying program. However, a major concern about the Fed’s decision is that it could be likened to the story of the boy who cried wolf. People will become less willing to take seriously whatever is said by the Fed until monetary tightening becomes a reality.
The policy statement issued by the FOMC on Wednesday suggests that the Fed may need more encouraging signals from the US economy before it reduces its asset purchases. The arguments over the debt ceiling and budget between the White House and Congress, as well as the tightening of financial conditions in the US — which Fed Chairman Ben Bernanke cited at a press conference after the FOMC meeting — appear to be other reasons behind the bank’s suspension of a policy change.
Initially, the Fed’s decision boosted global markets as investors’ had been reluctant ever since Bernanke hinted in May that the US central bank might begin tapering its asset-purchase program as early as this month.
Most people thought the Fed’s decision, compared with market expectations, demonstrated its policymakers’ higher cautiousness about the US’ economic outlook in relation to the winding down of its bond purchases. On Wednesday, the bank also revised downward its GDP growth forecasts for this year and next year.
However, the early euphoria over the decision quickly gave way to questions about how long the US central bank would keep its stimulus policies and the low cost of the US dollar. With the Fed delaying the normalization of its monetary policy, the market is now entering a new period of uncertainty, with investors wondering how long it will be before a liquidity crunch kicks in.
It is clear that the kind of tapering talk from Bernanke and other members of the FOMC had induced widespread speculations of such action over the past few months. However, there are concerns that the Fed’s latest decision not to taper will be a blow to its credibility and a setback for its effort to communicate with the public. There is no guarantee that this will happen, but it should not be taken for granted that investors will remain attentive to Fed policymakers.
The Fed might have missed a perfect opportunity to begin an exit from QE, which the market had widely expected. It had already been priced in the exchange rate and stock market volatility of emerging markets. No matter how hard Bernanke tried in his press conference to defend the bank’s stance, or how well policymakers clarify the bank’s move, last week’s decision not to taper, rather than a modest reduction in bond purchases, meant the markets have lost trust in the Fed.
The Fed’s unconventional QE will necessarily slow someday. In emerging markets in Asia and for Taiwan, investors will need to confront the ongoing uncertainties of tapering, while central banks must keep a close eye on the inflows of hot money and take necessary measures to maintain the stability of their national currency.