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UPDATED: October 22, 2013 NO. 40, OCTOBER 3, 2013
A QE Taper, Sooner or Later

At a meeting on September 18 the Federal Reserve unexpectedly announced that it would maintain its $85-billion monthly bond buying program, known as quantitative easing (QE). The decision came when most economists and investors expected a QE tapering and global capital was flowing back to developed countries.

Consequently, major economies had undergone sharp fluctuations. Gold prices jumped to their highest since January 2009 for a single day, while the yield rate of five-year U.S. Treasury Notes witnessed the most drastic decline since March 2009. The exchange rate of the U.S. dollar plunged, while that of emerging economies' currencies, with no exception, shot up.

The Fed's refraining from a QE taper had greatly alleviated the pressures on emerging markets, but it didn't mean there was no danger.

On September 20, James Bullard, President of the Federal Reserve Bank of St. Louis, suggested the Fed could still scale back its QE gradually in late October, if the data was strong enough. Esther George, President of the Federal Reserve Bank of Kansas City, even blamed the decision for doing damage to the Fed's credibility.

Comments by the two presidents promptly damped the optimistic mood. As a result, gold prices as well as America's three major stock market indexes (Dow Jones, S&P 500 and NASDAQ) erased the growth gained before. Under such circumstances, emerging economies may have to face another tough period.

Why is it that the attitudes of Fed officials can trigger such chaos? The answer is QE is still influential in the market. For emerging economies, pressures have been present at all times. Although the Fed didn't announce a QE scale back, the general trend has not changed. In the mid- and long-term, the delay would not make a difference.

Since the scaling back of the QE would happen sooner or later, the increase of interest rates by the Fed would start another round of capital backflows across the world. The latest forecast released in September showed that 10 out of the 17 Fed officials predicted short-term interest rates would not exceed 2 percent until the fourth quarter of 2016, and 14 of them believed the Fed would not begin to lift interest rates until 2015 or 2016.

Obviously, the QE withdrawal is a slow process. However, once it begins, the Fed would edge toward tightening monetary policies. Then, uncertainties in the global currency market would wear out emerging economies.

The delay will give emerging markets a chance to breathe, especially for high deficit countries like India and Indonesia. An expectation for cheap money in the market would facilitate financing. Nevertheless, these countries should go ahead with their ongoing adjustments in fiscal and monetary policies, and strive for a soft landing amid a prospective capital withdrawal.

As far as China is concerned, U.S. dollar outflow provides an opportunity for the yuan to go global. Considering emerging economies, especially those in Asia, have been under the influence of the Chinese economy for years, a wider presence of the yuan in the region would enhance the stability of the Asian economy and reduce dependence on the U.S. dollar.

This is an edited excerpt of a report by Anbound, a Beijing-based research company, published in Securities Times

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