Impact on Key Asset Markets and the US Reserve Bank Monetary Policy - Essay Example

Impact on key asset markets To begin with, the introduction of Quantitative easing in resulted in equities strengthening considerably. Through thee QE3, the government pledged to buy long-term securities to the tune of $85 billion monthly until the point at which the labor market became stable. Marking this achievement was Dow Jones Industrial Average and S&P recording high trading volumes in the first half of 2013. Following the setting of interest rates at below .25, Treasury yields slumped to a record low in 2012, with 10 year treasuries yielding figures below 1.40 percent while 30 year treasuries yielding around 2.46 percent. Further, demands for higher yields in the wake of a market with low-yield led to an increase in bids for corporate bonds, a phenomenon that led to a further slump in the yields, a situation that made it possible for companies to issue bonds with low coupons. The validity of this premise is because government ensured continued management of inflation, hence creating investor confidence. The market conditions also influenced the behavior of the dollar in terms of how it trades against other currencies. For instance, during the period spanning 2012-2013, other currencies had low interest rates as well; hence, the accommodative policy gave the desired results. The dollar strengthened against almost all major currencies of the world as the significant improvement in the real estate and the employment sectors of the economy spurred demand for financial assets of the country. Regarding future expectation, the recent communication by the Federal Bank that it will uphold the stimulus measures is good news for the stock market. The measures have been integral to the success of the bull market through 2014 and through the first quarter of 2015, hence are bound to continue delivering even better results. The current bull market is strong and vibrant, thus quite promising. In addition, the accelerating GDP growth driven by higher growth rate in consumption will translate to an increase in corporate profits, and hence an increase in stock prices. Finally, given the historical nature of US stock market, critical analysis shows great potential of a rise in price volatility. The wider belief has always been that the US stock market experiences a cyclical 20% correction every 635 trading days. However, nothing of this sort has been observed since five years ago. The future expectation on bond yields depend on how the market will develop both in the short-term and long-term. For instance, the FOMC made it clear that unless the situation changes drastically, there will be no rush in raising the interest rates. If the current, market condition is sustained with no major improvements, and with the interest rates remaining at their current value, trading in bonds may see a further slump. Furthermore, analyses show that foreign investment on bonds in the first quarter of 2015 remained low, a trend that may continue through to 2016. Much of the benefit of the policy has been strengthening of the Dollar against major currencies. This is expected to remain so even with improvement in market conditions that could result in raising of the interest rates since forecasts on oil prices show that they could go down even further. However, it is worth noting that an exit plan out of the .25 interest rates could result in an increase in inflation beyond the targeted 2 percent if not managed properly. If that happens, then the overall effect will be a slump in the value of our currency, which would translate to higher increase in consumer price index and a decrease in purchasing power. Based on these analyses, the current interest rates have made bonds and equities quite unattractive. Nevertheless, the recent announcement by the federal government that it will maintain the interest rates at its current value of below .25 has brought some confidence on investors. This means that trading on bonds and equities is bound to remain unaffected and hence no major risks that could warrant trading in fear is necessary. US Reserve bank monetary policy Significant improvement in the labor market has seen a decline in unemployment rate by nearly .5 percent. However, there is room for improvement in the situation, especially given the fact that a great percentage of workers are engaged on part time basis. Regarding other initiatives, pressure on inflation especially from oil prices has abated following the decrease in global oil prices. Inflation is currently under control, both in the food and energy industry as well as in other sectors. Even though the rate of inflation is currently low, there is fear among many market analysts that continued use of the highly accommodative monetary policies may be counterproductive, leading to grave inflation instead. However, because the odds for having a decrease in inflation rates outweigh that of having a higher inflation rate, the overall projection is that inflation will remain low. In my opinion, if for instance, the causative factors of inflation persist, then inflation I bound to stay low. On the contrary, if these factors ease at a relatively fast rate, then we are bound to see a fast reversion to normalcy, with a more than half chance that the reversal may overshoot the intended target of 2 percent. Regarding bank reserves, a point to note is that the Federal Reserve continues to pay interest on reserves. While this has been imperative to the recovery of the economy, most analysts observe that it has come of age, thus no longer effectual as a monetary expansion policy. Given the fact that banks no longer use these interests in creating new loans, I believe it is high time the Federal Bank stopped paying interest on the reserves. The fact that the Fed continues to pay interest on the reserves has made banks somehow content since they just sit on them. While it is evident that the interest that banks could get when they use such funds to create new loans is comparatively higher than what they receive from the Fed for maintaining the reserve, the reluctance towards making such a move is attributable to the requirement of a tie up capital when new commercial loans are availed. Currently, the major concern is about an exit plan. Tests are being performed with an objective of understanding the impacts that a suggested exit plan may have on key sectors of the economy such as employment and prices of essential commodities. In the event that the current plan promises sustained stability in the employment sector and an accompanying maintenance of inflation rates at about 2 percent, then its execution will come within the next one year. Given that this is highly likely under the prevailing circumstances, the overall expectation is that there will be an increase in interest rates within the said period, an occurrence that will lead to improvement in trading in bonds and securities, in addition to the aforementioned ones. References Federal Reserve Board. (2015). Education on monetary policy. Retrieved from https://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy Mikesell, J. (2013). Fiscal administration. Boston, Cengage Learning. The Conference Board. (2015). Global growth is not gaining much traction: volatility will prevail. Global Economic Outlook 2015. Retrieved from https://www.conference-board.org/data/globaloutlook/ Read More