Keep reading between the lines on Fed announcements

Dubai

Since the summer of 2013, the global financial markets have been introduced to a new policy term — ‘tapering’, referring to the slow, gradual exit from the quantitative easing policy, which involves the US Federal Reserve buying US government bonds on a monthly basis.

It was introduced to the financial lexicon in May 2013 by the then-governor of the Fed, Ben Bernanke, who told Congress he was likely to increase interest rates because the economy had sufficiently recovered since the 2007 crisis and inflationary pressures needed to be watched.

Bernanke did not realise that he had become the master of the global financial universe. His words alone about tapering quantitative easing caused shock waves in global financial markets with bond yields jumping and the emerging economy stock and currency markets diving sharply.

India, Indonesia and South Africa felt the worst of Bernanke’s power, with the authorities in India and Indonesia publicly criticising Bernanke — and the US — for being selfish in policy choice and not coordinating with the rest of the world.

The UK, the EU and China did coordinate in the summer of 2013 to calm the markets by announcing they would not increase their interest rates and that they would continue with their own low interest rate policies for quite some time.

The Fed announced it would not increase interest rates but would gradually end its quantitative easing policy — which it did between December 2013 and October 2014.

Ever since the tapering tantrum of 2013, the Fed has been very careful in its choice of words in announcing its interest rate policy. Janet Yellen, who took over from Bernanke, has learnt from experience and has sharpened her semantic skills in communicating with the markets when announcing the Federal Open Market Committee’s interest rate decisions.

There is a new science of linguistic interpretation of Fed announcements that is now commonly practised by financial market analysts. The consensus interpretation of Yellen’s choice of words in announcing the no-change decision on interest rates in July was that a slow process of interest rate increase would start towards the end of 2015.

This interpretation alone depressed the emerging economy markets with Malaysia in particular feeling the heat.

Since the summer of 2013 we have entered into a new phase of global financial dynamics where the policy needs of the US have started to diverge from the rest of the world, and especially with that of the Eurozone and Japan, causing significant volatility — especially in the currency markets — that is not restricted to the emerging economies.

The Swiss franc was also a casualty of the diverging policy needs as the peg to the Euro had to be abandoned

Although the improvements in the labour market might encourage the US to gradually increase interest rates, I am not convinced this will be in the interest of the US. There is still a household debt hangover with millions of US citizens holding high levels of mortgage and university education debts.

Even a small increase in interest rates is likely to increase defaults, putting US banks under serious pressure. Yellen is also aware of the interconnectedness of the economies and financial markets and the economic harm of higher interest rates on emerging economies is very likely to boomerang back to the US economy.

Therefore, I believe that the US is not likely to increase the interest rates for quite some time but will use its linguistic skills to prepare the global markets for its increase sometime in the future if the conditions both in the US and globally allow.

Meanwhile, we will continue to read between the lines.

— The writer is senior lecturer in banking, Manchester Business School.