The US Federal Reserve System (FRS) Starts Winding Down QE3

Then he made another announcement, quite unexpected by the expert community, that the Fed was going to cut on its third round of quantitative easing (QE3) – the program of buying government bonds and mortgage-backed securities. The FRS intends to reduce its monthly bond-buying plan to $10bn. The regulator will buy in the market government bonds to a total value of $ 40bn, mortgage-backed bonds – $ 35bn (at present, $ 45bn and 40bn respectively). Thus, the total volume of QE3 in January will drop from $ 85bn to $ 75bn.

The reason for a policy change has become the improved US macroeconomic statistics, and QE3 impending reduction is a sign of the Fed’s confidence in its further improvement. However, further tapering will depend on the specific progress that the US economy may make in the course of its recovery. So, if it becomes slower, any further reduction plans can be suspended for a few months.

The US stock market has already displayed its positive response to the regulator’s acts. As early as the next day after the news had been released, the S&P 500 market cap gained 1.66%, thus amounting to 1,810.65 points. The Dow Jones Industrial Average rose by 1.84% to 16,167.97 points, the NASDAQ Composite – by 1.15% to 4,070.06 points.

This market response is indicative of investor confidence in the continuation by the US FRS of its soft monetary policy. In particular, investors trust that the main interest rate will remain at the level of 0.25%. It is not planned to raise it until unemployment remains above 6.5%, and the inflation rate below 2.5%.

However, the inflation target of 6.5% is by no means the only factor influencing the interest rates. It means that the interest rates will stay low for a long time – in other words, that the rate of 0.25% will be maintained even if the unemployment rate declines below 6.5%. Thus, quantitative easing will continue throughout the period of 2014-2015.

A.L. Vedev – Director of the Structural Research Center