23 February 2019
Fed chair Janet Yellen has begun using the word "neutral" to describe the central bank's monetary policy, instead of “accommodative”, the word used for almost a decade. Photo: Bloomberg
Fed chair Janet Yellen has begun using the word "neutral" to describe the central bank's monetary policy, instead of “accommodative”, the word used for almost a decade. Photo: Bloomberg

Fed’s tightening policy will eventually dampen asset prices

The market is often quite sensitive to words and actions coming from the US Federal Reserve.

The US central bank indicated that it would consider reducing its balance sheet, according to the minutes of a Federal Open Market Committee meeting released last week.

Both Fed chair Janet Yellen and vice chairman Stanley Fischer have openly explained the policy direction.

Nevertheless, US equities are still at a record level while Hong Kong home prices continue to set new highs. Does that mean Fed’s tightening is not making much of an impact on the market?

Let’s review the Fed’s quantitative easing (QE) program and its subsequent impact on equities and housing markets.

The Fed launched an unprecedented QE program in the wake of the 2008 financial crisis, in a bid to reduce financing costs and revive the housing market.

In the first round of QE, the Fed purchased US$1.25 trillion worth of mortgage-backed securities and US$300 billion worth of US treasuries from November 2008. 

It further expanded the QE1 bond purchasing program to US$1.7 trillion as of April 2010.

During the two-year period, S&P 500 index surged nearly 40 percent while housing prices in Hong Kong jumped 55 percent.

The second round of QE began in November 2010, during which the Fed bought US$600 billion worth of US treasuries.

As a result, US equities rallied 13 percent while Hong Kong housing prices gained 30 percent between 2010 and 2012.

The Fed kicked off the third round of QE in September 2012, and announced an open-ended purchase of US$40 billion worth of mortgage-backed securities per month. It added the purchase of US$45 billion of US treasuries per month in December.

US stocks soared over 40 percent between 2012 and 2014, while Hong Kong housing prices rose 15 percent.

US equities outperformed as US corporate earnings started to pick up and new economy sectors like the internet and clean energy gained momentum.

By contrast, home price increases in Hong Kong moderated as the city’s economic growth leveled off.

Then in October 2014, the Fed ended the QE program and raised interest rates twice from late 2015.

Consequently, US stocks and Hong Kong housing prices started to lose steam, with both markets gaining only 10 percent since.

Over the last decade, the Fed kept injecting liquidity into the market, thereby creating a huge asset bubble.

However, both Yellen and Fischer have clearly stated that the Fed would move to tighten monetary policy in the coming years.

In fact, Yellen has recently described the Fed’ monetary policy stance as “neutral”, instead of “accommodative” – the word the Fed had used for nearly a decade after the financial crisis.

I believe in the next three years, the Fed’s tightening is going to be a major factor. It’s not hurting the asset prices yet, but over time the negative impact will be more obvious.

Not all sorts of assets will be subject to the same impact. Properties might be harder hit, for example, but tech shares may be less affected.

This article appeared in the Hong Kong Economic Journal on April 19

Translation by Julie Zhu

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal

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