News of the split on the future of the third round of quantitative easing surprised markets overnight. The January meeting statement had no sign of dissent, and it seems there was an agreement not to say anything until a study on the costs of continuing the current round of easing is considered at the Fed’s March meeting. That meeting, on March 19 and 20, has rapidly assumed critical importance to the future direction of interest rates, shares, commodities and currencies.
As a result of the disclosure, markets thought rates would rise soon. So investors sold off shares, commodities (gold, copper and oil all fell sharply) and the value of high-yield currencies such as the Australian dollar, which dropped more than a cent, to around $US1.0245 from $US1.0365 on Wednesday in Asia. The euro also fell, US bond yields rose, with the 10-year security hitting 2.01% for a second time in a month. Australian 10-year bond yields jumped to 3.59%.
The knee-jerk reaction was despite the fact that an end to the Fed’s easing would be the strongest sign yet that the country is escaping the lingering impact of the GFC. For countries such as Australia, rising US interest rates would be welcome because the value of the dollar would come under more pressure. A well-timed rate cut here could knock the dollar to around parity or the greenback, or just a touch under.
Interestingly, gold dropped $US40 an ounce (it had a similar fall last Friday, but then recovered some of that plunge). Overnight it should have risen sharply. The fall indicates that much of the speculation in gold in recent times has been driven by the cheap money financed by the Fed and other central banks.
So why these seemingly panicky moves? Well, markets have been worrying that the Fed could end its zero-bound interest rate policy sooner than 2014, as it has been saying now for a couple of months. And there was more data, this time from the US housing sector, that confirmed demand for new homes is growing more quickly than many people had believed. To lift rates, the Fed would look at industries like housing for confirmation that the recovery is strong, but it would also have to forget about its main checkpoint in any decision on rates: that US unemployment fall below 6.5% (it’s currently 7.9%).
The housing data is the best example that the Fed’s three rounds of quantitative easing since 2009 are finally working. Attempts in the first two easing cycles to stabilise the banks and lending generally have worked, but it has taken much longer to kick-start housing through moves aimed at driving down the cost of home mortgages.
Employment is rising slowly (but unemployment remains too high) and retail sales are up, along with profits. But wages remain stagnant and haven’t really moved much for two years. However, it’s clear from the January home building report that the US new housing industry is now stronger than it has been for four to five years — starts and permits on new homes were a bit lower in January (for weather reasons), but the industry continues to lift employment as work expands.
The data shows that private building permits in January were 35% above the level in January 2012, a sure sign of the strengthening rebound in the sector. They are now running at an annual rate of 925,000, the highest since 2008. And much of the increase is coming in private homes, not apartments. Actual starts were at an annual 890,000 in January, down on December, but nearly 24% higher than a year earlier.
It is quite possible that in the next few months permits and starts will reach and top 1 million units a year. According to Fed figures, the balance sheet is currently around $US3.078 trillion thanks to the three rounds of easing undertaken. But it could reach or exceed $US4 trillion by the end of 2013 if the $US85 billion a month in purchases are allowed to go on till December.
And a small footnote about the UK. Overnight the minutes of the Bank of England policy committee meeting at the start of the month showed retiring governor Lord Mervyn King was defeated in an attempt to boost the bank’s existing easing of £375 billion. It seems that the two central banks are starting to worry about the same issues: how to exit the easing and the cost to market stability and interest rates.