The most frequently asked question by central bankers at the various gatherings at the BIS annual general meeting in Basel was:
Q: What do you think caused the market turbulence last week?
And there were nearly as many answers as central bankers. Here are a few:
A: It was very temporary and will disappear soon. Don’t worry.
A: Traders were surprised that the Fed’s forecast for growth was higher than the consensus of private forecasters, so they guessed the zero interest rate would not last so long.
A: It was a cynical response of major investors who think the Fed should do more
A: Poor communications. Ben should not have given a 7% threshold
A: No, it was not poor communications. People recognize the normalization will take more than simply unwinding QE. The normalization process will involve many other changes which we are uncertain about including exchange rate realignments.
A: The effect of QE is not well understood. Exit causes as much uncertainty as entry.
A: It is just the inevitable downside effects following any earlier positive upside.
A: Japan and the US are going in opposite directions, so it is very confusing to traders
When I was asked here was my answer:
A: I’ve been warning for quite a while that a big risk of QE would be the exit strategy. So what you are seeing is that risk being realized.
Q (a typical follow-up): But the FOMC or press conference announcement was small in terms of the change in the stock of assets that will be purchased.
A: No, it was actually quite large. Before announcement, the peak level of reserve balances could have reached $4.2 trillion. With Wednesday’s announcement, it will reasonably be expected to reach $2.8 trillion. That’s a cut in the expected stock of $1.4 trillion—about the same as the increase that will have occurred since the QE3 announcement last year: $2.8T – $1.4T (in Sept 2012) = $1.4T). So the effect should be big. (See here for calculations.)