QE3: Beginning of the end

Markets have been moving higher, with little support from fundamentals only on fuel of liquidity. The recent statements by the US Federal Reserve have now put them in a Catch 22 situation

Markets clearly did not like what it heard from Federal Reserve Chairman Ben Bernanke. Though the chairman agreed to continue its bond buying program, infusing $85 billion of liquidity in the system to keep it warm, his statements on the economy was what seems to have shaken the market.

Bernanke revised its economic forecasts for the US economy and kept the markets on tenterhook by saying that he will increase or decrease the quantitative easing (QE) as when the situation demands. In other words he has introduced another angle of uncertainty over QE in the markets.

Little wonder then that the US market fell by over 200 points and the 10-year bond yield shot up. Federal Reserves' statement has been read by the market as saying that tapering of its purchases will happen much sooner than earlier expected. According to his roadmap bond buying could be completely finished by mid-2014.

Bernanke expects the labour market to improve and unemployment rate to be in the range of 7 per cent, which will be the trigger for tapering the purchases. Unemployment rate currently stands at 7.6 per cent, lower from 8.1 per cent at the start of QE3. A rise in housing prices has been cited as one of the major reasons to indicate an improving scenario in the US economy.

Bond yields touched a high of 2.33 per cent after the statement were made, signaling that the market has already started discounting the optimism reported by the chairman.

Global markets are in a catch-22 situation. Under normal scenario a growing economy would have signaled a rising market. But this time around a better economy would signal stopping of liquidity to the financial markets and its diversion to other engines of the economy. Markets have been moving higher, with little support from fundamentals only on fuel of liquidity.

Even news of reduction in supply of this fuel is scaring the markets. Withdrawal of liquidity can be catastrophic.