Muted market reaction to the ending of QE2

AFTER months of speculation surrounding the end of the Federal Reserve’s second round of quantitative easing (QE2), Fed chairman Ben Bernanke finally announced a fortnight ago that the US central bank’s program of buying Treasuries on a massive scale was going to draw to a close. But, despite the forex markets being overshadowed by the QE2 behemoth for the last year, its supposed demise brought a muted reaction from the markets.

Why have the currency markets responded in such a muted fashion? “As we head towards the finishing line with QE2, the question we ask is: Do we see QE3?” says Steve Braithwaite, director and global head of FX trading at RBC Dexia. “QE2 has avoided the potential disaster that faced global markets, however sovereign debt issues continue to circulate across central Europe. This, coupled with lower PMIs, appears to have changed sentiment towards growth, or the lack thereof.”

Whether a further Fed intervention is christened QE2.5, QE3 or Ben Bernanke’s Crazy Treasury-Buying Roadshow, there are few people who do not think that we will see another round of quantitative easing should economic indicators continue to deteriorate. “Despite the rhetoric of Fed officials, it seems likely that the US central bank will monitor the economy’s ability to recuperate unaided over the summer months and apply a third term of QE if deemed necessary,” says Mark Thompson, senior commercial dealer at Global Reach Partners. He points out that the Fed will continue to reinvest funds from maturing assets into Treasuries, meaning that they will remain the largest buyer of their own government bonds. This is seen as a security measure with the aim of reassuring the markets. But according to Thompson: “If we see a marked deterioration in confidence, employment and growth data, it’s not unreasonable to assume more aggressive monetary policy will again be put to use.”

CONTRARIAN QE2 VIEWS
Though Kathleen Brooks, research director for Forex.com, agrees with the consensus that the end of QE2 will cause large, long-term effects on the markets, she takes a different view on the future of Fed interventions. With the shift in the political balance of power after the Republican landslide in last year’s mid-term elections, the makeup of Congress is a very different place to when quantitative easing was conceived. As such, she thinks the political tide may be flowing against further intervention. “I believe the end of QE2 is already distant history, consigned to economic textbooks, possibly in a chapter about how the Fed failed to save the US economy, but did manage to engage the ire of the Tea Party movement.”

Many will hope that we have seen the end of central bank intervention. But should the US economy continue on its downward slope, and especially if we have a black swan event, it is difficult not to see Bernanke and his Fed colleagues intervening in the markets once again.