Scaling back bond-buying could undercut liquidity: expert says

The US Federal Reserve's announcement that it will scale back its bond-buying program to stimulate US economic growth could undercut liquidity in China "at a delicate moment," according to an asset manager.

China's current interbank lending rate is at its highest since June when the central bank raised rates to discourage borrowing, a move engineered partially to prevent further shadow banking activity, said Patrick Chovanec, managing director of Silvercrest Asset Management Group and former economics professor at Tsinghua University.

"Part of the liquidity that's been provided is that there's been US dollar borrowing, both licit and illicit," Chovanec told China Daily on Wednesday after the Fed's announcement. "Dollars flowing into China that adds to the credit ability and that has been based on the assumption that QE (quantitative easing) would continue."`

The Fed's pulling back from monthly bond purchases could have implications for interest rates and currencies around the world, and Chovanec said that although China has less exposure to macro risk from the Fed's action, the move could "undercut liquidity at a delicate moment."

Bank of America Merrill Lynch's Ting Liu in a note to clients on Sept 2 said, "China will surely be affected by the incoming QE tapering, but we believe the QE tapering will have little material impact on China's growth, currency valuation and financial stability." He added that "with the rising uncertainty on emerging markets due to the coming QE tapering, the Chinese government most likely will put a special emphasis on financial and economic stability."

The Fed acted after months of speculation that it would begin slowing its controversial QE stimulus to the economy. Citing progress in lowering the employment rate and in economic conditions, the agency said it will "modestly" scale back its pace of purchases by $10 billion now and will buy $75 billion worth of Treasury and mortgage-backed bonds each month starting in January. It signaled the beginning of an end to five years of unprecedented government intervention in financial markets.

"In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases," the Federal Open Market Committee said.

The Fed will begin buying $35 billion of mortgage-backed securities and $40 billion of Treasuries, down from $40 billion and $45 billion, respectively. The Committee said that it sees improvement in economic activity and labor market conditions and that it is "consistent with growing underlying strength in the broader economy."

The Fed repeated that it would keep interest rates low, near zero, "at least as long as" the unemployment rate is above 6.5 percent.

The national unemployment rate fell to a 5-year low in November at 7 percent, but the Fed said that it anticipates it will maintain low rates "well past the time" that unemployment rates fall below 6.5 percent, and "especially if projected in flation" runs below the Committee's 2 percent target.

The Fed also stressed that it will closely monitor data on financial developments in the coming months and "employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability."

Asked about whether the $10 billion taper amount is a benchmark figure the public should expect in future announcements, Fed Chairman Ben Bernanke said at a press conference that the number falls within the "general range." However, the Committee said in its statement that "asset purchases are not on a preset course."

During the press conference, which was Bernanke's last before stepping down in January, Bernanke said that Janet Yellen, who is expected to be confirmed as his successor this week, "fully supports what we did today." After the Fed's announcement on Wednesday, the US Senate voted to pass a two-year budget deal that will reduce the risk of another government shutdown.

amyhe@chinadailyusa.com