Tampering Or Tapering?

by Michael J. Howell8. July 2013 22:23
Two conclusions emerge from recent US and European Central Bank policy comments: (1) the Fed seeks to clearly distinguish (a) 'forward guidance' on Fed Funds from (b) QE, which determines the risk premium on bonds. Thus taken together forward guidance and QE determine bond yields. However, contrary to popular belief we believe that QE raises and does not reduce bond yields. Rather it reduces all other risk premia. The Fed by seeking to taper QE is trying we believe to stop the hunt for yield and likely wants to fatten 'too low' risk spreads on instruments such as junk debt, (2) the decision by the ECB and BoE to include 'forward guidance' is an interesting step. The ECB is admittedly using more 'words ' and according to our earlier points cannot control risk premia without QE. Nonetheless, the important thing here is that a European 'forward guidance' clearly opens the way for monetary policies in the US and Europe to formally diverge significantly. This could be key in 2014.

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