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The low-down on the FED’s Quantitative Easing (QE) Plan

The low-down on the FED’s Quantitative Easing (QE) Plan

Every time Ben Bernanke (U.S. Federal Reserve Chairman) refers to tapering, the markets go into a whirl. It is thus no surprise that the prospect of Western military action against Syria has sent stock markets worldwide reeling.

Emerging markets, which helped pull the world out of a recession after the global financial crises, face heightened vulnerabilities after an exodus of cash and sliding currencies in anticipation of the US Federal Reserve’s looming tapering of its $85 billion in monthly bond purchases, planned to start September 2013. Concerns over the security of oil supplies across the Middle East, which pumps a third of the world’s oil, drove Brent crude oil to a six-month high of $117.34 a barrel.

Due to all the uncertainty in the market, there is a strong possibility that tapering will be delayed until December 2013. Stocks and bonds have produced outstanding returns during the recovery period that followed the 2008 financial crisis, despite economic growth that is well below historical norm. The expectation is that, once the Fed begins to pull back on its stimulus, the markets may begin to perform more in line with economic fundamentals, which means weaker performance. In the wake of the tapering news, bonds sold off sharply while stocks began to exhibit higher volatility than they had previously.

* Despite the rising tensions in Syria, some strategists said budget battles in Washington may be the more worrisome issue. The U.S. is expected to bump up against its federal debt limit in mid-October. Treasury Secretary Jack Lew has said the Obama Administration will not negotiate spending cuts in exchange for an increase in the debt ceiling, while congressional Republicans hope to cut spending on social programs. A bitter fight over the debt limit in 2011 led to the first-ever downgrade of the U.S. credit rating, and the prospect of a self-inflicted wound like a debt default could easily rattle markets. "If the debt ceiling debate heats up to the point that it is seen by the Fed as creating the kind of uncertainty that dampens consumer confidence, and you see the price of oil escalate, further eroding confidence and consumer spending power, the Fed could announce a considerably smaller scaling back than initially planned," said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.

"The most serious obstacle to a tapering of QE is the fact that the U.S.economy seems reluctant to show the sustained improvements the Fed is looking for," economists at Cornerstone Macro wrote in a research note on Wednesday. "To deal with all the risks, the first step down is likely to be small of the order of $15 billion or so."


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