Across The Border | How the Fed’s balance sheet unwind and return to financial ‘normalisation’ will hit China

The US’s post-crisis-era policies could hammer asset prices across the world, and exchange rates in emerging economies

Reading Time:3 minutes

A Chinese vendor waits for buyers at his fruit stall in a market in Beijing. For China, the Fed’s reduction in its balance sheet will put the People’s Bank of China in a difficult position, say analysts, with many financial institutions already facing tighter liquidity due to the ongoing regulatory crackdown. Photo: EPA

Published: 1:00pm, 15 Jun 2017Updated: 10:45pm, 15 Jun 2017

A decade after the global financial crisis crippled markets, the US Federal Reserve is poised to revise its post-crisis-era interest rate policy and wind down its US$4.5 trillion balance sheet – a move that could hammer asset prices across the world, and exchange rates in emerging economies.

The Fed on Wednesday night raised the key short-term interest rate by another 25 basis point to a range of 1 per cent to 1.25 per cent at the conclusion of its two-day policy meeting.

But Fed chair Janet Yellen also announced that the US central bank had decided to reduce its bulging balance sheet, which ballooned fivefold during the quantitive easing era to counter the worst economic recession in the US since 1929.

The Federal Reserve;s rates decision shown on a television on the floor of the New York Stock Exchange on Wednesday. It is hiking a key interest rate for the second time this year and planning to reduce the size of its $4.5 trillion balance sheet. Photo: AP

By cutting its holdings of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession, the move is being viewed as more aggressive than previously thought, and clearly shows that’s reducing its balance sheet is now a priority over rate rises.

Taking the knife to its balance sheet will inevitably lead to a tightening of liquidity conditions, and according to Zhou Xi, an analyst for Bohai Securities, the new policy “will typically cause a spillover effect on the rest of the world”

“For the Fed, it’s the normalisation of its crisis-era monetary policy. But for some other economies, it could probably wreak havoc, ” said Zhou.