The End Of An Era For The Fed

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What's going on?

On Wednesday, the Federal Reserve (the “Fed”) announced that this October it will start reversing quantitative easing (“QE”), an emergency measure it began using to combat the 2009 financial crisis. It’s a dry subject, but pretty important :)

What does this mean?

QE is a policy whereby a central bank buys bonds in order to push up their prices, and thus lower interest rates (how does that happen? Click here). The Fed started QE during the financial crisis: its target interest rate was already very low and it sought other methods to make borrowing (and thus spending) easier – but now it’s confident enough in the economy to reverse course and reduce its bond investments. In addition, the Fed suggested that it would likely increase its target interest rate later this year – which, judging by the market reaction described below, surprised investors.

Why should I care?

For markets: Investments moved to reflect a greater likelihood of higher interest rates in the near future.

The dollar rose almost 1% against other major currencies – as higher interest rates give currency investors better returns, all else being equal. Banking stocks rose about 0.7% on average, as rising interest rates tend to improve banks’ profits. Also, government bond prices fell (because the Fed will, essentially, begin selling the bonds it currently owns).

The bigger picture: Central banks around the world are slowly removing the support they’ve been providing their economies.

Earlier this month, the European Central Bank announced it will soon start to scale back its own quantitative easing program. And last week, the Bank of England signaled it would likely soon reverse the interest rate cut it announced after the Brexit vote. While these moves aren’t radical in themselves, it’s significant that central banks, globally, are withdrawing support for their economies by allowing interest rates to rise.

Originally posted as part of the Finimize daily email.

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