The Federal Reserve’s Quantitative Easing programme holds a soft spot in many Asian bankers, investors and issuers’ hearts.
Through the first, second and third renditions of Quantitative Easing (QE), an excess of capital out of the US has bolstered investment into Asia, cutting yields to record lows, giving life to the region’s emerging domestic bond markets and giving Asian companies the confidence to make their capital market debuts.
But news last week that the Fed may slow the QE this year has caused blood levels to rise and an atmosphere of pre-panic to set in, at least in some quarters.
Just one day after the Fed released its minutes of its last Federal Open Market Committee (FOMC) meeting held March 19-20, which reveals that the central bank may slow QE this year if the job market continues to improve, Asian bankers have voiced concern, wary that this may be the beginning of the end of easy issuance, low yields and lots of liquidity. The sentiment heightened after Philadelphia Fed president Charles Plosser spoke to a Hong Kong audience on the importance of winding down QE as quickly as possible.
In particular, the Fed’s balance sheet may reach US$4 trillion by the end of 2013 if the central bank continues to buy US$45 billion of Treasuries and US$40 billion of mortgage-backed securities monthly. And Plosser referenced that the Fed has US$1.8 trillion of excess bank reserves, and may continue to grow to US$2.25 trillion if the central bank’s policies continue. "That may require the Fed to sell assets at a somewhat faster pace than contemplated in the principles adopted in 2011," he reportedly said.
While true that the analysis may be a bit premature considering the shaky jobs data to come out of the US on April 11, the messages serve as a wakeup call to Asia’s capital market which has come to rely on these inflows from the West.
One loan syndicate source voiced palpable fears to Asiamoney PLUS. He’s wary that a slowdown of Operation Twist will first prompt rates to rise. This will lead to outflows from Asia. And then currencies will crash, and then bonds will crash. Armageddon probably won’t be far behind.
But to all market participants in a tizzy, Asiamoney PLUS recommends that everyone take a deep breath - all will be okay.
The whole point of this exercise is that the Fed is airing plans to slow its stimulus, not stop it – yet. It’s all a bid for pre-crisis monetary policy normalcy. It’s also prudent to let people know far ahead of time what the central bank’s plans are so markets can be ready and investors can allocate their portfolios accordingly.
The reality is that QE won’t last forever, and the question for the Fed is the appropriate time to wind-down. Estimates have long suggested this won’t be until 2014 at least, and even if the Fed cuts its spending from US$85 trillion to US$40 trillion, down to US$20 trillion and to zero over the course of several quarters, that’s still a neutral stance for the Fed – and that’s in not removing that liquidity from the system. It will be a gradual event, and the idea is to begin when the US economy is strong enough through recovering housing and banking sectors to separate from its safety tether.
That said, the timing is still tricky for the US as it prepares for sequester cuts in the coming months and as it still struggles to maintain job growth. These are two major reasons to keep up the US$85 trillion of spending monthly, which means Asia won’t have to worry about potential outflows so soon.
Also for Asia, there is no need to feel the party is about to end: with the Bank of Japan (BoJ) vowing to double the yen supply in two years by buying ¥7.5 trillion (US$77.8 billion) worth of Japanese bonds monthly from May, money will continue to pour in.
Japan’s own QE could be even more important to Asia than the US’, given the region’s geographic proximity to Japan and the country’s inherent interest to invest in North Asia, South and Southeast Asia. The BoJ’s buying will go far to offset any holes Fed creates.
The size of Japan’s QE, at least for now, is comparable to the Fed’s asset-buying, so the global markets should see similar outflows. And as it’s expected to last for another two years at least, the programme may continue after the Fed’s QE grinds to a halt, whether that be, 2013, 2014 or 2015. It’s a cushion that regional markets can look forward to.
In all, Asia has little to fear about an abrupt end to its wave; the Fed isn’t cutting QE just yet – and even if it does, the region’s debt markets will likely be just fine.
QE has been a helpful tool to support eastward bond-buying and it’s certainly something that issuers and investors alike should ride, but all good things come to an end. But for Asia, that day hasn’t come.