Subdued market reaction to Fed’s well-signalled unwinding

The US Federal Reserve Wednesday announced it would begin to unwind its asset purchase program. The move was expected and the mild market reaction was in line with that. The small reaction was also likely connected to the fact that asset purchase programs remain in action in Japan and the euro zone.

In brief, Fed chair Janet Yellen announced the Bank’s intention to beginning selling off the assets it has purchased in the past ten years.

Quantitative Easing (QE), was introduced by then Fed chair Ben Bernanke in 2008, as a response to the credit crash and economic fall out that followed. It worked by propping up the stock markets and bolstering the economy with the additional money it pumped into the economy.

That Yellen is now confident enough to begin reversing QE and removing the $4.5 trillion worth of assets from the Fed’s balance sheet, suggests the program has been a success. Indeed, the reason it is beginning now, is that the central bank is confident the US economy is in a strong enough position to handle the slow removal of the financial stimulus the bank has injected.

While it all sounds good, clear and new, there were caveats in the announcement:

• The unwinding would be slow – just $10 billion of debt will be sold off per month to begin with. That will rise to $50 billion if things run well, there are no shocks and the economy remains healthy.
• Bonds won’t be sold – they’ll just be allowed come to a natural end and instead of being re-invested, the Fed will pocket the profits.
• The QE reversal can be halted at any time it appears the economy or markets can’t handle it, or need a break. This is perhaps the most important one, and also the one that has provided the reassurance the markets needed over how flexible the Fed will be.

The S&P 500 index ended the US trading session up 1.59%, while the dollar gained ground on the British pound and the euro. They were quite subdued reactions to the first ever reversal of QE. Hopefully, the long-term program of unwinding will produce such small responses, too.