Baseball great Yogi Berra once said, “In theory there is no difference between theory and practice. In practice there is.” He may have been on to something.
Last May, Fed Chairman Ben Bernanke introduced the idea the Fed’s economic stimulus program, known as Quantitative Easing (QE), might be ratcheted down sooner rather than later. The concept, that easy money – the Fed has injected about $2.75 trillion into financial markets during the past five years – could soon be behind us, threw global markets into a tizzy.
Expectations that interest rates in more developed economies would move higher as QE tapered off caused investors to pull money from emerging markets (where many had sought higher returns). This created challenges in emerging countries with large current account deficits (deficits that occur when total imports exceed total exports, making a country a debtor nation).
So, what will happen when the Fed actually begins to buy fewer bonds? Pundits are mixed in their opinions. Some believe markets may become more volatile; others believe markets have already factored in the effects of tapering. In August, the Financial Times described it this way:
“The beginning of the end for QE matters greatly as for the past five years central banks led by the Fed have actively encouraged investors to pile into risky assets. With QE suppressing interest rates and more importantly, the volatility of prices, investors duly obliged and sought risky assets. Now with the Fed thinking about reversing some support, this summer’s turmoil may be a taste of what is coming in the form of higher long-term bond yields and market volatility. Some will argue the Fed’s taper is pretty much reflected by the sharp rise we have seen in long-term Treasury yields since May.”
We’ll know more when the Federal Open Market Committee announcement is made. Over time, however, it may not be all that easy to quantify the effects of more accommodative monetary policy in the United States, if that’s what the Fed chooses to do this week. There are other flashpoints that could affect markets, as well, including economic stressors in emerging markets, decisions on Syria, and upcoming Washington budget battles.