The aftermath of the Fed’s surprise decision to buy US Treasuries was dramatic across markets, with Treasury yields dropping, equities rallying and the dollar sliding. The Fed has now moved from what was initially credit easing to full blown quantitative easing. Effectively the Fed is throwing everything but the kitchen sink at the problem and is arguably the most aggressive central bank at present.
What are the implications:
1) Equities like the news and it helped extend a rally that had been in effect for a couple of weeks. But the momentum is likely to run out quickly as the bad news starts to filter back into the market once again.
2) Commodity prices rallied, especially gold. Why? Inflation concerns intensified following the Fed move due to the risk that the Fed will not be able to end it’s programme of “printing money” quickly once the economy starts to turn around. Commodities are set to rally further.
3) The dollar dropped like a stone, and although it is difficult to see it regaining much ground in the wake of a central bank that flushing the market with dollars, its falls looks overdone. For now, the dollar looks like it has entered new weaker currencies and may even benefit if the market appetite for risk declines again.
4) Other central banks in particular the European central bank will be under huge pressure to follow the Fed. The Bank of England, Bank of Japan and Swiss National Bank have already moved but not as aggressively as the Fed. So far the ECB has been reluctant to act and technical issues mean that it can’t act in the same way as the Fed. Nonetheless, the rise in the euro means that something may need to be done and quickly.
5) The move by the Fed shows that policy makers are doing all they can to turn things around, but this is merely a reflection of the severity of the crisis. Economic recovery is still some months away