The Federal Reserve this week announced the end of its quantitative-easing, bond-buying program. The Fed also said it will keep its target range for the federal funds rate at zero-0.25%, where it's been since December 2008, "for a considerable time." Both moves were expected.
This was the third round of QE since 2008. It's likely to be the last, given the improving growth and employment situation in the U.S. now.
The end of the Fed's bond purchases represents a tightening of a monetary policy that still remains easy by any measure. After all, the Fed isn't unwinding its bond purchases yet. As the securities it owns mature, the Fed will roll over the proceeds into new ones. What's more, investors generally don't expect the Fed to start raising short-term interest rates until mid-2015.
The Fed this week noted "solid job gains" and said that labor-market slack is "gradually diminishing." At long last, job growth is running at its fastest rate in eight years, and new unemployment claims are at their lowest level in 14 years. The unemployment rate has tumbled to 5.9%, although this is partly because many people have left the work force.
Also this week, the Commerce Dept. said the U.S. economy expanded at a solid 3.5% annual rate in the third quarter. Also, the economy grew at a 4.6% pace in the second quarter after contracting 2.1% during the first quarter.
Despite the improving economy, though, inflation remains well below the Fed's target 2% rate, just as it has been for the last 28 months. And global factors are likely to dampen the need to raise rates here.
In sharp contrast to our improving economy, growth is slowing in the rest of the world. The 18-nation euro zone is struggling to avoid its third recession since the 2008-09 financial crisis. China, the second-biggest economy after ours, now is expected to grow this year at its smallest rate since 1991. Japan's economy, the third largest, currently is at a five-year low pace. Economies also have slowed in many emerging markets. Europe, Japan, Russia and others face significant deflation risks.
Commodity prices, which reflect the global economy, have fallen sharply over the last several months. This has happened despite drought, geopolitical tensions and easy monetary policies, including zero interest-rate policies in most of the world's developed economies.
While the Fed has ended QE, Europe and Japan are fully engaged in their own developing or fully developed QE2 programs, which effectively lower interest rates and currency values.
This morning, Japan's central bank, the Bank of Japan, unleashed yet another attack on deflation and weak growth. The BOJ's campaign already was even more aggressive than the Fed's ever was. Now the central bank will further expand its yearly asset purchases to 80 trillion ($730 billion) from the previous 60 trillion-70 trillion range.
The European Central Bank may be the next to move. Like the BOJ, the ECB has three related core goals: boost economic growth, increase inflation and weaken the currency.
No wonder the long-undervalued U.S. dollar has embarked on an overdue rally. Not only is our economy relatively strong, but yields of our government bonds, while historically low, are much higher than those of other major developed nations. With 10-year Treasury issues currently paying 2.3%, other government 10-year yields range from 0.45% (Japan) to 0.85% (Germany) to 2.2% (United Kingdom).
The Federal Reserve's bond-buying campaign has helped to fuel one of the longest bull markets in American history. Opinions vary widely on the effectiveness of QE for the real economy. But the Fed's bond purchases were critical in stabilizing the financial system and aiding the economy in moving through the financial crisis. The U.S. has since economy has outperformed those of other developed nations.
U.S. stocks account for 50% of the MSCI All Country World Index, a world stock benchmark. Many pundits contend that U.S. investors should be widely diversified to take advantage of global trends while reducing the risk of overinvesting in the U.S. market.
Broad diversification and low correlation among asset classes (stocks, bonds and alternative assets) historically has paid off over extended time periods. But as John Maynard Keynes, both an excellent investor and leading economist, famously stated: "In the long run, we are all dead."
His point wasn't that the long term is unimportant, but that what happens along the way makes a big difference. It's not enough to say that everything will work out in the end.
As you may know, I have long favored U.S. equities as the world's best investment asset. I still do. But foreign developed and emerging markets, after a long period of underperformance relative to the U.S., now deserve increased scrutiny.
This article originally appeared in the Mind Over Markets column. Never miss an issue. Sign up to receive Mind Over Markets by email.
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