US Fed decides to taper by US$10 bln per month; stocks rally; economists see green light for OCR hikes in NZ

By David Hargreaves and David Chaston

Westpac economists say the move by the The US Federal Reserve to start "tapering" its supportive monetary policy gives the green light for our Reserve Bank to start hiking interest rates early next year.

Early today the Fed said that it would reduce its Quantative Easing programme by winding down its bond purchases by US$10 billion a month to US$75 billion a month, but has signalled that interest rates will stay low for a long while.

The US sharemarket soared on the news, based on relief that the reduction in bond purchases was less than it might have been, along with the comments from the Fed about monetary policy remaining accommodative.

Westpac economists here said they regarded the Fed's decision to taper as "important encouragement for the RBNZ to hike the OCR" next year.

"This supports our call for a March OCR hike. However, we doubt that this news would push the RBNZ into hiking the OCR in January, particularly if the NZD/USD remains high."

The Fed had led global markets to believe that tapering would commence in September and in the build up to that global interest rates rose. When the taper didn't happen this caused disruption.

Our RBNZ has expressed its frustration that the taper didn't occur in September - as markets had been led to believe - because our central bank is potentially constrained in hiking our interest rates by the high value of the Kiwi dollar. Obviously rate hikes here - without the accompanying removal of supportive monetary policies in the US - run the risk of driving the dollar ever higher.

The move by the Fed to now begin the tapering process, albeit very gradually, does now clear the way for our central bank to commence what is expected to be a fairly aggressive hiking of interest rates next year in response to a fast growing economy and emergence of inflationary pressures.

The Westpac economists said the accompanying statement from the Fed today seemed aimed at ameliorating the market reaction. The Fed explained that the pace of future tapering was not pre-determined, and would depend on evolving conditions in the labour market and inflation.

The said the key sentence was: "If incoming information broadly supports the Committee's expectation of ongoing improvement in labour market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings." 

The Fed added a new sentence into its guidance on interest rates, suggesting it intends to hold the Fed Funds Rate at near-zero rates for longer than previously signalled: "The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal." 

The Westpac economists said markets reacted initially to the taper, by sending 10-year US Treasuries higher and the NZD/USD lower.

"However, the market reaction quickly reversed in response to the dovish signal on interest rates. At the time of writing, NZD/USD had retraced to 0.2 cents above its pre-taper level, and US 10-year Treasuries were only 2bp lower."

The Detail of the Fed announcement is:

It will now only purchase US$75 bln per month, down from US$85 bln per month.

Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month. 

The key benchmark of a 6.5% unemployment rate remains.

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

In the data released with the decision, it sees the 2014 unemployment rate in the range 6.3 - 6.6%.

The exchange rate has seen the NZ dollar rise to US$0.825 from US$0.822.

And here's comment from Harbour Asset Management

The US Federal Reserve (Fed) has announced that it will taper its Quantitative Easing (QE) purchases from $85bn to $75bn a month. At the same time it has strengthened its guidance on overnight interest rates. Markets have breathed a sigh of relief.

Surveys ahead of today’s decision put the chances of a QE taper at 30-50%, with most seeing it as a close call. Much of the uncertainty surrounded the tactics of the decision: the role of chair soon moving from Bernanke to Yellen; thin December market conditions; and markets still nervous from the impact of the May-June taper talk.

In the end the Fed has rightly focused on the economic fundamentals and announced that: “in light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases”.

The Fed has not set a fix course for further tapering, which will be taken in measured steps based on the economic data. The statement went to great lengths to emphasise that monetary conditions are still stimulatory (i.e. it is the stock of QE purchases not the flow that matters): “The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates”.

Importantly, the Fed has strengthened its forward guidance on overnight interest rates saying that: “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the 2 percent longer-run goal”.

With the offsetting effects from QE tapering and stronger forward guidance, foreign exchange and interest rates markets were little changed after the announcement. As such, in our opinion there are few implications for the RBNZ. They still look likely to be the first central bank to start tightening in 2014, and having to deal with the implications of an elevated NZ dollar.

After becoming nervous about the chances of QE tapering in recent weeks, equity and commodity markets have breathed a sigh of relief on today’s news, with the S&P 500 up over 1.5% on the day. More generally, with this policy decision out of the way, markets can refocus on economic news and fundamentals.

There was also news overnight of stronger than expected German business confidence and lower than expected UK unemployment. Both serve as reminders that we are entering 2014 with an encouraging global macroeconomic backdrop. This morning’s NZ GDP release of 3.5% annual growth highlights the domestic economic momentum.