Dollar plummets and sharemarket drops $20 billion: What does the US Fed’s decision to end economic stimulus mean? A SmartCompany Q and A

The United States Federal Reserve chairman Ben Bernanke announced a rollback in its bond buying program later this year, further signalling an improving US economy.

On the back of the announcement, the Australian dollar dropped to around US92 cents, while yesterday it was worth US94.2 cents.

The US Federal Reserve’s decision was nothing new, but in chairman Ben Bernanke’s speech he changed the timeline of the cutbacks, saying the stimulus could end by the middle of next year.

“Overall, the committee believes the downside risks to the outlook for the economy and the labour market have diminished since the fall, but we will continue to evaluate economic conditions and risks as they evolve,” Bernanke says.

The Fed’s updated economic projections were also released on Wednesday and this predicted a faster fall in the unemployment rate.

With the Australian dollar continuing to fall and $20 billion wiped off Australia’s sharemarket, SmartCompany asks, what does it really mean?

So the US Federal Reserve has decided to scale back stimulus measures, what is it actually doing?

The Fed is in essence going to stop buying assets and printing extra money. Currently, it’s engaged in a quantitative easing monetary policy, wherein the central bank buys financial assets from commercial banks and other private institutions to increase the amount of currency in circulation. This is designed to help stimulate the US economy.

The Federal Reserve is purchasing $85 billion bonds and other assets each month, but as the US economy has started to improve recently, particularly with falling unemployment rates, this has provided scope for The Fed to cease its stimulus program.

But, these changes depend on US economic growth and an improving jobs market.

JP Morgan economist Tom Kennedy told SmartCompany the biggest implications of this move will be seen “across financial markets”.

“The Australian dollar has dropped this morning to under US93 cents. With the Fed printing less money and buying fewer assets, this is positive for the US dollar and negative for the Australian dollar.

“The sharp decline we’ve seen is all on the back of the tapering talks it affirmed,” he says.

Hang on, so why is a decision which was made miles away to do with a whole different country impacting upon our dollar?

To buy $85 billion of assets each month, the Fed has had to print excess money and expand its own balance sheet. The increased supply of funds lowered the value of the US dollar, but inflated the price of the Australian dollar in comparison.

Kennedy says with the stimulus measures now being reduced, we’re likely to see an unwinding of this effect.

“If you look at the Reserve Bank of Australia’s commentary since the currency easing cycle, it flagged the Australian dollar remains high in terms of historical standards.

“The Australian dollar is tracking around US93 cents today, but just months ago it was around 104 to 105 cents and when you compare the value of the Australian dollar to commodity prices, it’s clear it’s been overvalued,” he says.

Rather than being a concern, this lowering of the Australian dollar is a correction to a more accurate value.

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