Market shouts as Fed twists, says SIG’s Rupert Watson

Rupert Watson, head of Asset Allocation at Skandia Investment Group gives his view on the latest efforts of the US Federal Reserve to bring stability to the US economy.

The Federal Reserve announced that it would seek to ease financial conditions by increasing the maturity of its bond holdings. The Fed will sell $400bn of US government bonds with a maturity of less than 3 years and buy the same amount of bonds with a maturity of more than 6 years. The Fed hopes this will lower longer term interest rates and as a result boost the economy. This has been widely referred to as ‘Operation Twist’.

The Fed also announced that it would reinvest maturing principal payments from its holdings of agency and agency mortgage backed securities into agency backed mortgage securities in an attempt to lower mortgage rates.

While the Fed twisted, the market has shouted. US equities fell sharply after the announcement with Asian and European stock markets off sharply as well. Markets were hurt by the Fed’s downbeat description of the economy and concern that with interest rates and bond yields already at record lows, there is little the Fed can do to boost the economy. Ongoing European worries continue to weigh on markets as well.

While the Fed’s move was widely expected, its concern over the outlook has spooked an already nervous market. With sentiment and the economic outlook deteriorating, a global response by central banks and governments to support financial markets and economies seem likely. In addition to the possibility of further moves by the Fed, we now also expect the Bank of England to announce more QE and for the ECB to cut interest rates this year. In addition it remains critical that European policy makers reach agreement on measures to support the European banking sector and government bonds markets as soon as possible.

 

Rupert Watson is head of Asset Allocation at Skandia Investment Group.

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