After the announcement of the Federal Open Market Committee (FOMC) meeting last week (December 18) which ensures that the Federal Reserve Bank (U.S. central bank) will begin reducing its fiscal stimulus package early in 2014, the response or reaction of the world’s financial markets is ordinary. Unlike what was previously imagined that the world’s financial markets will respond negatively.
For information, the U.S. Federal Reserve (the Fed) will begin a gradual reduction (tapering off) of securities purchase starting January next year. FOMC decided to reduce the monetary stimulus from USD 85 billion per month to USD 75 billion per month starting next month.
The decision was reached at the Fed commissioners meeting was attended by Fed chairman, Ben Bernanke, who will be replaced next year. The FOMC decided to reduce the speed of asset purchases, adapting to the development of labor absorption. That’s the press statement of the Board of Governors of the Fed, last Thursday (December 19).
Housing bond purchases will be reduced from USD 40 billion per month to USD 35 per month, while the purchase of U.S. Treasury bonds was reduced from USD 45 billion per month to USD 40 billion per month. The Fed opened up opportunities of reduction of monetary stimulus disbursement after January according to the least economic development data.
If the information indicates that FOMC’s expectations of development in the labor market and inflation is close to the long-term projections, the monetary stimulus will again be reduced. Interestingly, the Fed, decided to gradually reduce bond purchases, also advised to keep interest rates low. The point is to keep the trend of the U.S. economic recovery keep running on the corridor.
The first-phase reduction of bond purchases is USD 10 billion to USD 75 billion per month starting January 2014. The cut came from mortgage and treasury. Here FOMC saw that risk on economic outlook and the labor market in U.S. has nearly balanced. In addition, FOMC will reduce the pace of asset purchases at the next meeting.
Supposedly, the FOMC’s move is surprising to some investors. Better prospects for the economy and the labor market in U.S. marked the biggest ever historic turning point for monetary policy experiment. The Fed’s statement once caused the stock index to fall, but it quickly returned to the positive direction. Bond prices also fell, but then rose again. The U.S. dollar rose against the euro and the yen.
In general, analysts and economists believed that the Fed eventually withdraw its monetary stimulus funds after delaying for a long time, i.e. May 22, 2013 when Bernanke made a speech about planning to reduce the stimulus package.
Then, why the global financial markets did not respond negatively to the tapering off decision? Because although the Fed gradually reduces bond purchase amid improving labor market conditions, it kept interest rates low. This is done to prevent sharp market reaction t to the tapering issue.
The U.S. central banks keep the lending cost stable until unemployment rate reaches 6.5 percent. In November 2013, unemployment rate reached 7 percent, the lowest in five years. The fed also lowered expectations of inflation and unemployment rate over the next few years. Unemployment rate has dropped faster than expected.
The Fed expects unemployment rate to fall between 6.3 percent and 6.6 percent in 2014 from the previous forecast which is between 6.4 percent and 6.8 percent. To note, the Fed keeps interest rates low in the long term. Low interest rate is maintained until employment rate reaches 6.5 percent and inflation no more than 2.5 percent.
U.S. government bond purchase program by the Fed is actually the core of the policy during the subprime mortgage crisis era. The first quantitative easing program was launched in the middle of the financial crisis in 2008. The latest quantitative easing was last launched 15 months ago after seeing the economy growing slowly from the Great Recession. The program was to stimulate investment and labor recruitment.
Some economists are increasingly confident that the Fed will cut its bond purchases looking at the recent growth in employment, retail sales and housing as well as budget ideal in the U.S. Congress. Based on a Reuter survey, only 12 out of 60 economists expect that the Fed will cut its stimulus-purchase program last week. While 22 economists expect tapering off in January, and partly March 2014.
Meanwhile, the Fed Chairman, Ben Bernanke will end his term on January 31, 2014, two days after the close of the fed’s first policy meeting on January 28-29, 2014. Janet Yellen, is expected to soon get a confirmation from the Senate to replace Bernanke. Janet was one of those who support the bond purchase policy.
Thus, it makes sense if the world’s financial markets, including the domestic financial market, did not give a negative reaction to FOMC’s decision to stop the stimulus package gradually, because market is already making adjustment (rebalancing or adjustment) since May when Bernanke was planning this.
So, it is too much to respond negatively to the Fed’s policy, because actually it is a positive signal that if the U.S. economy improves, it will bring a positive effect on the recovery of the world economy. Eventually, Indonesian economy will enjoy the positive effects, as reflected in the increase in the potential of goods to the U.S. In the end, the local stock index and the exchange rate will improve because it is positively affected, directly and indirectly, by the tapering off.
Business News - December 31, 2013