Hawkish Fed: World economy braces for QE exit, rate hikes

The much dreaded Fed taper is almost here. US Federal Reserve Chair Jerome Powell has indicated it would soon raise interest rates, but also cease adding to its massive stockpile of bonds by early March.The bottom line: A key support for the global economy is going to be pulled away sooner than financial markets had been betting.Bloomberg Economics expects Group of Seven central banks will add just $330bn to their balance sheets this year, a sharp drop from the more than $8tn added during the pandemic in a bid to ease markets, contain borrowing costs and spur demand and risk-taking.The two biggest US banks have raised their forecasts of how quickly the Fed will raise interest rates this year, with Bank of America predicting a move at every meeting to tackle the highest inflation in four decades.JPMorgan Chase & Co has separately lifted its call to five hikes in 2022 from four previously. Chief US economist Michael Feroli said Powell’s remarks following last Wednesday’s meeting “were clearly intended to dissuade the market from expecting a quarterly tempo of rate hikes.”Goldman Sachs economists have also joined Wall Street peers in forecasting the Fed will raise interest rates more aggressively than they previously expected.They now predict the US central bank will lift its near zero benchmark by 25 basis points five times this year rather than on four occasions. Meantime, the Fed’s counterparts are also ending or slowing the bond-buying which accelerated in the coronavirus recession with some even looking to reverse it.The Bank of Canada has signalled it could tighten policy in coming weeks having ended so-called quantitative easing in October. Clearly, it’s not a synchronised tightening across the global economy.There’s an emerging divergence as major central banks in the English-speaking world look not only to stop quantitative easing but begin quantitative tightening, the term given for shrinking balance sheets, while others keep on easing monetary policy.Japan remains glued to stimulus even as it slows the pace of its asset purchases and the European Central Bank is seen as being still more than one-and-a-half years away from raising rates although it too is reducing net purchases.China, which avoided QE through the crisis, has switched to stimulus mode to cushion the economy from a property slump.The Fed sets monetary policy by adjusting the interest rate big banks pay each other for overnight loans: The Fed funds rate. Changes in that rate ripple through the economy, affecting employment, output and the price of goods and services. The Fed’s policy direction impacts the whole financial world, especially emerging markets and economies where local currencies are pegged to the dollar.Amid all the uncertainty, here is the key question: What does the exit from QE mean for the world economy? If the tightening enables central banks to get on top of rampant inflation, then it could help extend the recovery from the 2020 slump, especially if it acts as a substitute for higher benchmark rates.But if the process ends up roiling markets, it could have the opposite effect by cutting off the flow of credit to consumers and businesses, hitting their confidence.