Thursday, 30 October 2014 12:56

US Quant Easing - where to from here

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The US Federal Reserve have announced that they will cease purchasing bonds and other securities as part of the Quant Easing program (affectionately known as money printing).


We discuss this with Dom Guiliano, portfolio manager at Magellan Financial Group and get his views as to what this might mean for interest rates both in the US and Australia in the medium term.


Below the video we have also provided a transcript of the video.




















Mark: I'm here with Dom Guliano, portfolio manager at Magellan Financial Group. Thanks for joining us today Dom, and we're talking about America now. We've been around the round the world so far. And theoretically America's going to finish their money printing program later this year - or that's what's expected. Are you able to give us an update of where that, which is commonly as quant easing. Can you give us a fly over view of where that program's at and what some of your likely expectations are from here? 

Dom: Right, so--

Mark: A tough question for you. 

Dom: So, the Federal Reserve is being quite clear about it's intent to phase down the quantitative easing program over the next couple of months. So, we should probably see new purchasers of securities come down to zero, certainly by the end of the year. 

Mark: So they'll stop buying? 

Dom: They will simply stop buying. They will still have a very large balance sheet. 

Mark: Yes.

Dom: Of purchases that they have made, and we're talking about 2.4 trillion, that kind of number. But they should be able to keep that balance sheet under control. The next step, the next step, really then becomes one normalisation of monetary policy. So, the Federal Reserve has been flagging in a number of different ways that short term interest rates might move up from zero to something, over the course of - or beginning sometime next year. And there's a lot of speculation - in the second quarter, third quarter, first quarter. Like, we don't know and really we don't care so long as that direction's a good one. We expect, given the positive fundamentals that we're seeing playing out in the US economy, the strength--

Mark: Like unemployment and economic growth. 

Dom: Yeah, exactly. The economic growth continues to show positive indications. Unemployment continues to decrease, which improves household wealth. Propensity for households to buy is improving. The number of houses sold is increasing. House prices are increasing. Business investment is slowly increasing. So, all of the ingredients for a sustainable recovery and a strengthening recovery are there. So, whether it's one or the other, from our perspective, if it's long term investors doesn't matter too much. I think one area to be thinking about over the medium term is what normalisation might actually look like. Are interest rates going back to four and a half percent, four percent, five percent, three and a half percent? There's a bit of a question mark around that, given the nature of the recovery, given perhaps some structural issues. One of the areas that the Fed Reserve President Yellen has been talking a lot about is the quality of the unemployment rate. What she means by that is unemployment might be going down, but certainly the number of jobs that have been created - typically of weaker quality than we normally see in a recovery--

Mark: So more part time employment?

Dom: So, what kind of jobs - casuals - the average wage is less, indeed, wage growth over the last number of years has been weaker than you normally see coming out of recovery. So there's some underlying weakness that is being masked by the headline unemployment rate, which might colour the nature of monetary policy over the next couple of years. 

Mark: What would be your gut feel on how you will see normal monetary policy coming out in America, as in whether you think rates are likely to normalise given where they have come from, where they are at the moment? 

Dom: If you look at history, normal kind of suggests something between four and five percent is where interest rates should line up. But there's a lot of interesting stuff going on around the world, so how long it takes to get to get to normal is quite a different question. And when I say, "interesting stuff going on around the world," - you've got Abenomics (Japan) continuing and Japan has got it's own quantitative easing program, right? So, they're busy buying bonds in overseas markets, including US treasuries. We talked earlier about the weakness in the Euro zone, which is likely to provoke a quantitative easing program of some sort out of the Euro zone. And again, it's a weakness out of that market, money printing out of that market. You've got a slowing Chinese economy. Now, North America and the United States doesn't operate as an island, it deals with the rest of the world and there will be some feedback loops into how monetary policy and the nature of the recovery in the United States progresses as it will. So I think you need to keep that in mind. 

Mark: Yeah, yeah. I think one of the other things, just to finish off on is - we're talking about America here, but everything impacts globally. People in Australia will think, "Well, that's got nothing to do with us.  So, American interest rates are likely to have some impact on Australian interest rates I would have thought. What's your view on that? 

Dom: Oh well, very much so, I suspect Glenn Stevens of the Reserve Bank hopes that there is a significant impact in rising interest rates. So, typically, if markets behave as they should behave, when the interest rates go up in a country that supports their currency relative to other currencies - so if interest rates go up in the United States, that should result in a strengthening of the US dollar, relative to other currencies, including the Australian dollar. Which means a weakening of the Australian dollar relative to the US. Similarly a weakening of the Euro relative to the US. Now that of course will be beneficial for our export sector and also should reduce imports, so you should see some import replacement and that should be beneficial to the Australian economy. 

Mark: And given that Australia requires funding from overseas, if we're competing for capital with America, if they increase their rates, does that automatically mean that our rates have to go up to compete with that? 

Dom: Look, the central banks do have a fair degree of control over the level of interest rates. That wouldn’t be my primary concern. Markets are fairly liquid. The primary borrowers actually are the Australian Banks, and they've got a very good degree of access offshore . The mechanism really won't play through in terms of increasing interest rates in the United States automatically meaning increasing interest rates in this country. But there are beneficial impacts all through the currency. 

Mark: Well really good information and particularly relating back to how it affects us here in Australia. Dom, thank you for your insights, that's fantastic, and I wish you well for the rest of the year. 

Dom: Thank you very much Mark. 


This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

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