US tapering of QE could put brake on global growth: QNB

Qatar National Bank yesterday said the tapering of quantitative easing by the US could act as a brake on global growth.

In a press statement, QNA said QE (quantitative easing) has already had a drastic impact on exchange and interest rates in recent months. QE is the creation of money and purchase of financial assets from banks. As a result, banks would have more cash to loan and would eventually lead to a smoother process of financing projects.   

Tapering of QE means that the US Federal Bank will slowly reduce QE, meaning that banks will have a smaller amounts of cash to finance projects.

As a result of that policy, QNB says global growth would be reduced. The statement has linked the weakening of the currencies of emerging markets as a result, in part, by the US Federal Reserve’s decision.

Emerging market currencies have weakened and global interest rates have risen significantly, as capital has flown out of those market assets. Stock markets have reacted strongly to the decision before its implementation: the S&P 500 stock index has fallen by 4.8%; the US dollar appreciated by 620 pips against the euro and the US 10-year sovereign bond yields rose from 2.19% to a peak of 2.74% on July 5.

The distress about QE tapering started when the chairman of the Federal Reserve, Ben Bernanke, said on June 19 that the pace of bond purchases might be reduced as the US economy was strengthening.

There was a knock-on effect in emerging markets (EM) to Bernanke’s statement. QE had created surplus liquidity in global financial markets, which was directed towards emerging markets in search of higher yields. This enabled emerging markets to have record low interest rates and an environment generally conducive to higher growth than in advanced economies.

QNB said that concerns about QE tapering led investors to withdraw capital from emerging markets to take advantage of higher US bond yields. This led to: a 7.4% drop in the MSCI EM stock market index in five days; weaker EM currencies (JP Morgan’s EM currency index fell 2.5% also in five days); and higher sovereign bond yields.

The sudden drop in EM exchange rates forced a number of central banks to hike policy interest rates to help support their currencies. Central bank rates have been increased in Brazil, India, Indonesia, and Turkey.

The drain in liquidity from EM and rising long- and short-term interest rates are likely to have a negative impact on growth by restricting capital available for investment and making borrowing more expensive.

According to QNB, the Federal Reserve tried to backtrack on the comments in July to temper the concerns about QE tapering. Members of the Fed’s monetary policy committee restated that QE will only be tapered when the economic data is strong enough.

Bernanke himself said on July 11 that QE would remain in some capacity for the foreseeable future. The result was that the US government’s 10-year yields stabalised at 2.61%, lower than the rates in the first week of July.

The drop decreased the differential with European rates, leading to a stronger Euro against the US dollar. The euro has been further boosted by recent better-than-expected manufacturing data.

Market expectations are for the Federal Reserve to begin tapering its bond purchases from $85bn per month to 65bn per month following its monetary policy meeting on September 17th-18th. This is likely to lead to higher long-term US sovereign bond yields, driving up the cost of borrowing and acting as a brake on global growth.