The officials at the Federal Reserve are divided over the timing of the balance sheet reduction. However, investors are betting that the bank will start this complicated process by September. While this may have far reaching consequences for the US, Asian economies will also be affected significantly. For instance, money that has flooded the Hong Kong markets and reached China will now retreat. The world should be ready to face the aftermath of the US central bank balance sheet reduction amidst testing financial times.
What Is the US Doing And Why?
The country faces one of the biggest financial crisis of modern times in 2008. Central banks around the world, including the US, introduced the untested ‘quantitative easing’ policy to keep their economies afloat. In this policy, new notes were printed to maintain enough liquidity in the market. The central bank went ahead to buy bonds and re-invested the money into buying more bonds as the old ones mature. The three-year quantitative easing process and its aftereffects have left $4.5 trillion in the Fed balance sheet. The bank maintained only $1 trillion in its balance sheet before 2008. The entire exercise helped in averting deflation in the economy, but it came at a cost.
Now the Fed believe that they should mend their balance sheet. The Feds will not reinvest the proceeds of the previous bonds which will help in clearing off its records. The reason behind this is simple. It has been about a decade since the last crisis struck. If the Feds do not shrink their balance sheet now, they will be at a disadvantage when the next crisis hits.
Impact on Asian Markets
The Chinese economy is one of the only bright spots to look forward to in Asia. The US data is not very promising, and investors will respond accordingly. On Friday, the Asian markets remained positive, as Wall Street moved higher after inflation data release and stock trading found favour amongst investors. Consumer inflation remained unchanged from June. The expectation for a sharp growth in the economy is subdued.
The US dollar index fell to a 10-month low. It is likely that the dollar will keep struggling for some time. The investors are not expecting a December rate hike as expectation fell to 43.1 percent from 55 percent. Other currencies will soar against the dollar in this circumstance.
Quantitative easing, as we mentioned above, is an unrest strategy, especially for forex traders. No central bank has ever shrunk its balance sheet before, and speculations about the consequences are ripe. For now, Asian corporations, which were large borrowers of US Treasury Bonds, will have to pay higher debt financing costs.