Fed tapers monthly asset purchase by $10bn amid foreign currency volatility

The US Federal Reserve reduced its monthly asset purchases by another $10 billion to $65 billion last night as it shrugged off emerging market turmoil at chairman Ben Bernanke's final meeting.

Its decision – without any acknowledgment of the volatility that has hit emerging markets – offers no respite to countries such as Turkey and South Africa that have raised interest rates in an effort to stabilise their currencies.

US equities extended losses after the central bank announced the further reduction in its monthly bond purchases.

The S&P 500 dropped to a low of 1,774.51, for a fall of 1 per cent, having been down 0.6 per cent before the policy statement was released.

The further tapering shows the Fed still expects strong growth this year and was not unduly disturbed by a recent weak US jobs report.

It is in line with Mr Bernanke’s guidance of a $10 billion taper at each meeting this year and means Fed asset purchases are still on course to halt by the end of 2014.

“Growth in economic activity picked up in recent quarters,” said the Fed in a little-changed statement.

“Labour market indicators were mixed but on balance showed further improvement.”

Track record
The decision means Mr Bernanke hands over to successor Janet Yellen with little drama, after a tumultuous eight years in which he successfully battled the worst financial crisis since the Great Depression before launching three waves of asset purchases to nurse the economy back to health.

He leaves with the unemployment rate down to 6.7 per cent from a peak of 10 per cent and an optimistic growth outlook for 2014.

But Ms Yellen will also inherit a bloated $4 trillion balance sheet and the tricky task of normalising policy without triggering inflation or further financial instability.

With the Fed gradually winding down its monetary easing, investors have been selling the currencies of emerging markets with economic imbalances, leading their central banks to raise interest rates.

If that monetary tightening slows growth in emerging economies or hurts financial assets in the US, it could feed back into a weaker expansion for the US and affect the Fed’s calculations later this year.

By ignoring the volatility at this meeting, the Fed showed it will only be swayed by developments that affect the US economy.

The sell-off in emerging market currencies intensified yesterday despite a string of surprise rate rises by central banks as investors warned policy makers would need to take tougher action to restore confidence.

The rally that followed the dramatic midnight rate hikes by Turkey’s central bank fizzled out as analysts said monetary policy had not been tightened as much as initially thought.

South Africa’s central bank also shocked markets by raising rates – but the rand continued to plunge after policymakers presented it as a one-off move that would not change its overall stance on inflation.

Leaping lira
Turkey's lira swung sharply and ended the day little changed from the level that it had reached before the rate rise.

The South African rand fell 2 per cent against the dollar in volatile trade, despite the 50 basis point increase in the central bank’s base rate to 5.5 per cent.

Investors signalled that they wanted to see more aggressive and sustained action from central banks before they regained their appetite for emerging markets assets.
– (Copyright The Financial Times Limited 2014)