US economy held hostage by shutdown

President Obama last night officially endorsed Janet Yellen as the next chair of the Federal Reserve
President Obama last night officially endorsed Janet Yellen as the next chair of the Federal Reserve

FEARS over the potentially disastrous consequences of the US shutdown mean the Federal Reserve’s plan to slowly bring the economy back to normal have been put on ice.

As Fed vice chair Janet Yellen was officially nominated by President Barack Obama as the next chair of the Federal Reserve, minutes from the American central bank released last night suggested that it will not be able to taper quantitative easing (QE) this year at all.

The text shows the reservations of the central bank’s board in trimming its massive $85bn a month asset purchase programme, ahead of September’s decision on rates due to the possibility of a US shutdown and the risk of America defaulting on its debt if Congress fails to agree to raise the borrowing limit, currently set to be reached on 17 October.

“A number of (members) pointed to heightened uncertainty about the course of federal fiscal policy over coming months, including the potential for a government shutdown or strains related to the debt ceiling debate, which posed downside risks to the economic outlook,” the minutes released last night said.

A majority of Fed board members were previously in favour of a reduction before 2014.

With the Treasury’s extraordinary measures now only a week from exhaustion, one of the world’s biggest money managers announced yesterday that it had sold all US  government bonds maturing late in this month and early in November. Nancy Prior, president of Fidelity’s money market group said: “In our position as money market managers we have to take precautionary measures.”

Analysts now suspect that tapering may not even have begun when Yellen takes up her post at the end of January.

“There is now a risk that the tapering will be delayed until early 2014 and that asset purchases will persist into the second half of next year,” said Paul Ashworth of Capital Economics.

Yellen’s comments at last night’s press conference, also suggested that she will lean towards continued easing. While promising to maintain stable prices, Yellen leant heavily on the Fed’s responsibilities to limit unemployment. She said: “More needs to be done to strengthen the recovery, particularly for those hardest hit by the great recession.”

Obama also hinted as to which part of the Fed’s dual mandate he thought Yellen would prioritise, referring to unemployment as “our most important economic challenge right now”.

Earlier in the day, the International Monetary Fund (IMF) raised the prospect of a nightmare shock to the world’s financial system if the US defaulted on its debts.

According to the IMF, an “adverse scenario”, in which long-term interest rates jumped by one per cent, could cause a traumatic $2.3 trillion (£1.44 trillion) loss on bond portfolios.

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