Uncertainty over QE2 has markets rattled
Investors are bracing for volatility in the market this week as the US central bank is expected to unveil a controversial and much-anticipated stimulus plan that could further weaken its currency.
The Federal Reserve is expected to announce details of an asset-purchase scheme, referred to as its second round of quantitative easing (QE2), before its two-day policy meeting concludes on Wednesday. Investment banks estimate the amount of money the central bank will ultimately pump in through the programme could range between US$1 trillion and US$2 trillion.
Global equity markets have shot up since the Fed signalled in September that it would tolerate higher inflation levels if growth initiatives can reduce unemployment. The central bank has already injected US$1.7 trillion into the financial system and maintained near-zero interest rates.
But investors have grown skittish as the central bank meeting approaches. Some worry policymakers will overstep their bounds, while others fear they will not do enough.
'Everybody has been looking to QE2 and the Fed is now in a difficult position because unless it does quite a bit, it risks disappointing expectations,' said Geoff Lewis, the head of investment services in Hong Kong for JP Morgan Asset Management.
'In the short term anyway, it's probably better to buy the rumour and sell the news.'
Anxiety about the QE2 scheme has helped scuttle the recent rally in the Hang Seng Index. The benchmark slid 1.8 per cent last week to 23,096.32 points, dropping for a second straight week. It had advanced in each of the seven previous weeks, tacking on 15.3 per cent over that period. Local main board turnover has topped HK$100 billion seven times in the past two months after only doing so once in the rest of the year.
Hong Kong and other regional markets have rallied on the back of heavy fund flows from overseas markets. Those capital inflows helped drive up local currencies at the expense of the US one. The yen, for example, has strengthened 12.6 per cent against the US dollar this year, according to Bloomberg data.
The QE2 scheme could add impetus to the fund flows, as it is expected to further weaken the US currency by increasing its supply in the market.
'Whilst there could be some disappointment [this] week, we still think that every market will be driven higher [eventually] by quantitative easing,' Lewis said. 'It is going to have further positive impact on risk assets generally, on commodities, and it will drive the US dollar down.'
The pace of depreciation in the US dollar has slowed recently, as market speculation intensified on the potential size and scope of QE2. The yen gained just 0.5 per cent against the greenback in the past two weeks, Bloomberg data shows.
'If the QE2 is less than expected then the US dollar may have a rebound in the short run and global stock markets may have a pull-back,' said Patrick Yiu Ho-yin, managing director at CASH Asset Management, who tips the Hang Seng to trade from 22,800 to 23,800 in the near term.
Uncertainty about the Fed's implementation of QE2 is expected to keep markets rattled even if the programme is unveiled this week. But it should help ease fears of a long-term economic slowdown in the US, said Crystal Chan, head of investments for Hong Kong and China at Legg Mason Hong Kong Asset Management.
Controversial move
Investors are skittish ahead of the Fed's 2-day policy meeting
The maximum amount, in US dollars, the central bank may pump into the financial system through the scheme is: $2tr
