‘Taper.” In many investment circles, it’s now a dirty word. Reading some market commentators, you could be forgiven for thinking the world will end when the U.S. Federal Reserve turns off the tap on its bond purchases.
And now you can add emerging countries to the list of the disgruntled. The U.S. central bank hopes to cut down this fall on the $85-billion (U.S.) it buys every month in bonds and mortgage-backed securities and to drop the strategy, which is designed to create lower longer-term interest rates, entirely by mid-2014. Bond yields in the United States have jumped sharply in anticipation of this withdrawal. As a result, investors have been moving out of countries such as India, Indonesia and Brazil, which don’t look as attractive as they once did. (Mind you, those countries weren’t complaining when all the money was pouring in.)
Much of the taper criticism has focused on how outgoing Fed Chairman Ben Bernanke has imparted the central bank’s intentions – or rather, how he allegedly miscommunicated them. He didn’t. Mr. Bernanke has stated time and again that the Fed would stop resorting to extreme measures – the bank’s balance sheet has swollen to more than $3.6-trillion – when the outlook for the U.S. job market improves. The number of unemployed has dropped by 1.2 million in the past year. The numbers are there for everyone to see.
The “miscommunication” theory just doesn’t hold up. Investors who have grown addicted to cheap money are just sorry to see the end of the Fed’s third round of quantitative easing. This has led at times to a perverse market reaction, where good employment news is greeted with disappointment, while poor news is cheered.
All this fuss has clouded the main and obvious point: The world’s biggest economy is getting its groove back. Okay, it’s not quite party time again. But manufacturing activity, jobless claims, the participation rate, the unemployment rate – now at 7.4 per cent, its lowest level since the end of 2008 – are all moving in the right direction. Americans who had given up hope are now looking for jobs, which is an amazing thing given the severity of the financial crisis.
That is great news for the United States, for Canada and for the world as a whole – investors included.
By keeping interest rates so low, the United States has, in effect, subsidized anyone who has taken on debt. No country wishes to do this, especially not for any prolonged period of time. But even as the Fed pulls back on buying bonds, its monetary policy will remain easy. It won’t even consider raising its benchmark interest rate before the unemployment rate drops to 6.5 per cent. Short-term borrowing costs will remain near zero for some time. And even when it does start to inch upward, interest rates will remain extremely low by historical standards.
In the meantime, the U.S. dollar has been rising – and the Canadian dollar is sinking relative to it. When the greenback rises vis-à-vis the loonie, Canadian exports are more competitively priced in the United States.
Higher rates will also help retirees earn more income on safer investments, although there is a lag before financial institutions raise the dismal rates offered on savings and term deposits. And it will do wonders for the country’s pension funds, given that their unfunded liabilities are determined by long-term interest rates. (The lower the rates, the more assets a pension fund must hold to keep its income promises.)
So everybody should just ignore the economists and traders who obsess about finding out the exact day and minute the Fed will starting pulling out of the bond market. It’s going to happen. And there is quite a lot to be said about returning to some sort of normal.