Fallout from the Federal Reserve’s Decision

Sept. 19, 2013 - PRLog -- Investors were caught off guard on Wednesday when the U.S. Federal Reserve announced it would continue to support the U.S. economy through asset purchases and low interest rates. The world expected the Fed would start to slow its stimulus package. However, that did not happen and the markets reacted with a roar.

Forex comparison service ForexBrokersAZ.com discusses the near and longer term fallout from the Fed’s decision.

How the financial markets reacted

Bond yields subsided after rising over the past weeks. Sovereign yields across emerging and developing European countries were the first to fall, sometimes by a large amount. In particular, the yield on 10-year Greek bonds fell below the 10% mark.

Stock markets can expect an influx of liquidity from yield driven investors. The Dow Jones closed Wednesday’s trading session on a new 15,676 point high. Euphoria spread to Asian stock markets, with the Japanese Nikkei closing Thursday’s session up +1.8% and the Indian Sensex also moving in the right direction.

The currencies of emerging countries, which had been battered in recent months, appreciated in the wake of the decision. Conversely, the US Dollar fell overnight reach $1.35 for 1 Euro - a boon for US exporters and energy-intensive industries.

Macroeconomic implications

The Fed reminded investors that it works towards employment and inflation targets. It does not consider that economic growth is strong enough to warrant tapering the stimulus problem, particularly at a time when the U.S. Government is considering tightening fiscal policy to reduce the budget deficit.

Whilst the unemployment rate has fallen steadily over time and stands a little above 7% today, the fall is primarily due to workers leaving the job market, rather than a surge in economic growth.

Macroeconomic considerations aside, the disconnect between investors’ expectations and the Fed’s decision raises questions. Is the Fed to blame for setting the wrong expectations or letting them take hold? These are matters Ben Bernanke’s successor may need to address.