No major firm anticipated this, but by staying on course with its $85 billion-a-month purchases in Agency MBS and Treasury securities, the Fed has sent a strong signal to global financial markets: We will stay fully committed to QE3 until inflationary expectations become well-anchored at the 2% level and until U.S. hiring begins to accelerate. These are tangible benchmarks (the former garnered from TIPS prices, and the latter from U.S. weekly jobless claims) that are disclosed and digested by investors at least on a weekly basis. In other words, investors no longer need to guess–global liquidity will continue to stay elevated until the U.S. employment picture definitively improves and inflation hits and stays at 2%.
The U.S. economy is still far away from hitting these benchmarks. U.S. inflation in August was lower-than-expected, with year-over-year CPI growth at 1.5%. According to the Cleveland Fed, ten-year inflationary expectations as garnered from TIPS prices are still near a record low, while the ECRI U.S. Future Inflation Gauge (a leading indicator for U.S. inflation) just hit a 19-month low (in the Euro Zone’s case, this indicator just hit a 40-month low). Geopolitical events notwithstanding, certainly the U.S. economy is at no significant risk of higher inflation anytime soon.
In essence, the Fed has: 1) sent a strong signal that global liquidity will stay elevated, and more important, 2) prior to any tightening, investors would get strong signals from both market indicators and the Fed–i.e. there will be no surprises. It is thus not surprising to see India and Indonesia–two countries with strong recent outflows–spiking up immediately after the publication of the Fed’s FOMC statement. As we are writing this, India is up more than 3%, while Indonesia is up by more than 8%. Keep in mind that both markets were down earlier this morning. Asia is going to go gangbusters tonight. More important, the Fed has eliminated any potential systemic risk in Asia (prior to today’s announcement, we believed India and Vietnam were the two countries most at risk to Fed tapering). U.S. home buyers, as well as gold and oil speculators, can also celebrate.