The long awaited “
taper”
has finally arrived, with equity markets taking the announcement in
stride and treating the relatively more hawkish statement from the FOMC
as an early Christmas present. The feeling that the American economy
was on strong enough ground the Fed could reduce their monthly asset
purchases by $10bn sent stocks to record highs, with the S&P
rallying from earlier lows to close up by 1.7% on the day. In addition
to the beginning of the “great unwind”, the Fed also made sure to
reinforce that tapering is not tightening (despite 10yr treasury yields
in the secondary market leaking higher post-announcement), and enhanced
their forward guidance by suggesting that the exceptionally low level of
interest rates would remain in place “well past the time that the
unemployment rate declines below 6.5%.”
The amendment to the previous communication around forward guidance
and the 6.5% unemployment threshold gave markets slightly more
confidence that the first interest rate increase from the Fed is still a
long ways off, especially if inflation remains subdued and below the
FOMC’s long-run objective; 12 of the 17 Fed officials now expect rates
to be at or below 1% at the end of 2015. While yesterday’s decision to
lop off $10bln of monthly asset purchases was slightly ahead of when we
forecast the initial taper to come, the choice to pair the reduction in
balance sheet growth with enhanced forward guidance was in-line with our
expectations, and not necessarily outside the realm of prospects for
what the Fed was capable of administering.
Bernanke’s press conference shed a little more light surrounding the
future path of monetary policy, and while he reiterated that the pace of
asset purchases were not on a preset course, should the incoming data
continue to show improvement like it has over the previous few months,
the pace of reduction (along with the breakdown of $5bn from treasuries
and $5bn from MBS) is likely to continue at subsequent meetings in 2014.
In short, the Fed will continue to remain data dependent, with
incremental gains in productivity and the labour market leading to the
gradual unwind of additional monetary stimulus. Bernanke also made sure
to reinforce the point that Yellen was instrumental in the shaping of
FOMC policy during the course of the meeting, signaling to markets there
would be continuity from the Fed when Yellen takes over for Bernanke in
January.
The reaction across asset markets was initially one of confusion, as
stocks, treasuries, commodities, and currencies all whipsawed back and
forth as traders and investors digested the news. After the dust
settled, the outcome was very much USD positive, with high-beta
commodity currencies like the AUD and CAD feeling the brunt of the
sting. The Loonie was squeezed lower as the USD bid-tone sent
USDCAD north of 1.07, while
AUDUSD dropped
into the low-0.88s, and USDJPY tested the waters above 104. The small
reduction of liquidity from the Fed sent the DXY ramping into the
mid-80s, while treasury markets were less impressed, and after the
initial knee-jerk reaction the US 10yr grinded higher to end at 2.897%.
The outcome of yesterday’s meeting reinforces our thesis that the USD
is poised to enter 2014 on solid ground, with the eventual unwind of
additional stimulus underpinning the big dollar as interest rates in the
secondary market gradually increase.
Equities traded in positive territory during the overnight session,
clinging to the back of gains seen on Wall Street with the Nikkei
positing an increase of 1.74%. While the Bank of Japan isn’t expected
to make any major policy amendments at their meeting tonight, the
negative trade balance data from earlier in the week will likely
continue to put upward pressure on
USDJPY as traders assess the growing divergence between monetary policy regimes in the US and Japan.
European bourses are seeing a similar shade of green on traders’
screens, with the majors playing catch-up to the Fed’s non-aggressive
taper decision as the Dax, FTSE, and Stoxx are up by 1.37%, 1.14%, and
1.49% respectively. After the initial spike that saw Cable trade into
the high-1.64s, GBPUSD has retraced those earlier gains, backing away
from the 1.64 handle as retails sales in the UK increased by less than
expected for the month of November. The y/o/y reading missed forecasts
coming in with only a 2.0% increase, however this was up from the 1.8%
that had been registered in October, as clothing sales were spurred by a
colder than anticipated month.
Heading into the North American open, futures are displaying a slight
weight to the tape, seeing a little bit of an easing from yesterday’s
aggressive rally.
Unemployment Claims,
Existing Home Sales, and the Philly Fed Manufacturing Index are all on
tap for later in the session, and while they will not have the same
market-moving power as the FOMC yesterday, a positive economic docket
will continue to put upward pressure on the USD as it reinforces the
unwind of QE. The Loonie struggles continue this morning, with little
interest from market participants to increase exposure to the
commodity-linked currency considering FOMC decision.
Copper futures are
down 0.74% Gold encroaches on the $1,200/ounce level, and WTI remains
flat just south of $98/barrel, so there is little working in the CAD’s
favour in terms of its traditional drivers.
Turning our attention to the beleaguered Loonie, domestic inflation
numbers are due out tomorrow and could give the CAD a slight reprieve,
or escalate the sell-off and send USDCAD to new highs depending on the
strength of the release. Expectations are that we see the core reading
remained pinned at an increase of 1.2% when compared to the last twelve
months, while the headline reading moves up from 0.7% to 1.0% over the
same measurement period. With the Bank of Canada taking a keen interest
on inflation remaining persistently below target, consumer prices will
have more of an influence on price action in the Loonie moving forward.
A warmer than expected reading would provide some relief to the recent
pressure the Loonie has succumb to, while a print that misses the median
analyst forecast will likely accelerate the upward momentum in USDCAD.
With price action stretching the upward Bollinger Bands, further
weakness in the Loonie would see the pair test 1.0750 at the top of the
trend channel drawn from the September rally, which if broken, would
open up room for the pair to make a run at the May 2010 high of 1.0850.
