The old saying about central banks is that it is their job to take the punchbowl away just as the party is getting started.
It is a marker of the strange times we live in that the decision by the US Federal Reserve Board to stop injecting additional funds into the economy – but to maintain low interest rates at historic lows at least until next year – will cause nervousness among investors.
The Fed is not so much withdrawing the punchbowl as refusing to add any extra booze.
Its response to the crisis which started in 2008 was the most dramatic of any of the international central banks. It slashed interest rates to near zero and engaged in what market participants call quantitative easing (QE) and the rest of us call printing money.
Buying securities
The Fed has increased its balance sheet to over $4 trillion (€3.2 billion) by buying various securities from the market and pumping in cash in return. Together with low interest rates, this has led to some revival in the US economy, where growth has outpaced the euro zone and unemployment has dropped below 6 per cent.
It was this drop in unemployment and an improvement in labour market conditions that were central to the Fed’s decision. The markets knew that QE could not continue forever, though last month’s upheaval in equity prices had led to speculation that the ending of it might be postponed for a period, fuelled by comments at the time by some members of the Fed’s key policy making committee.
However, chairman Janet Yellen has decided that now is the time to call it and start the slow return of policy to normal.
Slow growth
There are risks here. US economic figures are reasonably steady, but slow growth elsewhere in the world could take its toll. The decision could also affect markets in the US and around the world, particularly emerging markets, which could see funds leave once US rates start to rise.
Investors will now be asking when the Fed will actually decide to increase interest rates. Yesterday it said it would keep rates low for a “considerable time” – with expectations it will not start the rise until next year. In the meantime rates will stay low in Europe and the ECB will remain under pressure to engage in the kind of aggressive monetary stimulus which the Fed is now drawing to a close.
