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QE2 docks, what now for financial markets?

The end is nigh for quantitative easing. The Federal Reserve will stop purchasing Treasury securities at the end of this month, bringing to an end the stimulus programme started in November to try and kick-start the US economy after last summer's slowdown.

By Kathleen Brooks, Research Director

Since the start of the programme the Fed’s policy has attracted criticism, mostly because it hasn’t been particularly beneficial to the US economy. Instead of helping companies to create jobs and boost employment figures, money has seeped out of the US and found its way to higher yielding assets such as stocks and commodities.

This money has also been invested in emerging markets, and the Middle East hasn’t been immune.

Gulf stocks reaped Quantitative Easing policy benefits

After the announcement of QE2 last November the Dubai stock index jumped by nearly 20%, as money flowed into the equity markets. Since the Arab spring protests, regional stocks markets have come under pressure and are now fairly flat since November last year. But there can be no denying that Gulf stocks benefitted from the QE2 effect.

Added to this, the latest uptrend in oil was kick-started by the Fed’s stimulus plan. It has risen from $70 per barrel to approx. $110 since October last year. Although part of this was due to the protests at the start of the year, the bulk of the move is attributable to the Fed.

If markets went up when QE2 started, surely they should come down when it ends? This sounds logical, but the reality might be a bit more nuanced. Some have argued that QE2 may cause stocks and commodities to bounce. This is all because even though the US central bank is expected to stop purchasing Treasuries in the coming days, it is not planning to sell them any time soon.

The slowdown in the US economy this year, unemployment is still at an unacceptably high 9.1%, means that now is not the time for tight monetary policy. So with rates going nowhere in the US, and unlikely to move quickly in Europe or the UK, investors will still search out higher yielding assets.

This means that if the Greek crisis gets resolved in the coming weeks, we could see stocks and commodities resume their uptrend.

Middle East inflationary pressures

While this is good news for investors and oil producers, the economic effects in the region are not so positive. Even after massive stimulus plans, cash reserves in Saudi Arabia are $480bn, after rising at their fastest pace in more than two years in April.

This rate of reserve accumulation is inflationary, and price pressures have been rising around the region. Egypt, the UAE and Kuwait are at risk from a spike in inflation as are the smaller states of Oman and Bahrain. This is because food prices feed into the inflation pipeline extremely quickly in the Gulf.

The political ramifications of this could be huge. The crises in Syria and Libya continue to escalate, and if prices increases continue there may be further protests in the poorer Arab states later this year.

So while the Fed comes to the end of its QE2 programme, now is not the time for complacency from the US central bank. Navigating through this slow patch in the recovery without inadvertently pumping up inflation pressures in the Gulf and elsewhere in the emerging world should be a major part of its remit going forward