Tapering in September looking likely

The crowd calling for the Fed to curb the pace of bond purchases in September had a number of reasons overnight to feel their call is looking good.

Certainly the added risk that the September FOMC meeting will herald a major announcement has been blamed for the pullback in equities. For us however, whether the Fed taper in September or December seems relatively irrelevant – since it will happen regardless - so given the difference between a few months it seems illogical to sell equities.

It seems to us that the market looks tired and a pullback would be healthy, although on current news flow it’s hard to make a case for any more than a 5% pullback. 

A clear out of tired long positions would entice a fresh wave of traders and longer-term capital with a move to 1780 potentially being seen over the medium term. We also expect these gains to coincide with a strong move higher in the DXY (dollar index) and thus should see a continuation of the correlation between stronger US equities and USD strength.

The overnight US trade deficit didn’t really provide the sort of strength we’d expect in the USD; however this was earlier coupled with more good economic numbers out of the eurozone and UK. Still the prospect of seeing the Q2 GDP print being revised up from 1.7% to between 2.3% and 2.5% is real, while we feel Q3 should improve even further to around 3%. 

Comments from Atlanta Fed President Dennis Lockhart and Chicago President Charles Evans were interesting; with Mr Lockhart calling for second-half growth of 3%, backed up by job growth of 180,000 to 200,000. He even suggested adding an extra press conference to the October meeting, which in theory plays into our idea that October will be the month that the Fed actually starts cutting the pace of asset buying. Charles Evans (a current voter) also backed a September tapering exercise and seems quite happy to allow a lowering of his threshold targets (6.5% unemployment, 2% inflation) with regards to increased rates, if the exercise helps anchor expectations of future rate hike.

So whether this two day sell-off in the US is something more substantial is yet to be seen, although our client base seems to think the pullback could amount to more with 74% of open positions on the S&P 500 currently sold short. Certainly Asian traders are acting more negatively, with Japan again at the heart of the rout with the Nikkei down 3%; whether we see another late session rally is yet to be seen. 

USD/JPY fell out of bed in early Asian trade hitting a low of 97.09 before finding buyers, with the JPY crosses also coping a beating. The price action in USD/JPY seems quite shaky at present, although today’s moves seem to be stop loss related after it broke through the recent low of 97.59 and a key options barrier at 97.50. Talk of Japanese investors increasing currency hedges of their recently purchased foreign assets (German and US bonds) has been a key reason behind the JPY strength, while there are concerns that the pace of monetary velocity (the frequency at which money is spent on goods and services over a period of time) is falling, with certain economic data points also not looking too flash. 

It’s also worth highlighting that in 1997 Japan fell back into recession after the government put consumption tax up from 3% to 5%, effectively costing Prime Minister Ryutaro Hashimoto his job and of course one of the fiercest debates is around the proposed hike in consumption tax due in April 2014; there is concern that the same fate could materialise this time around.

The ASX 200 is down 1.3% with a broad based sell-off at play. We’ve seen earnings from FOX and FXL (Flexigroup) and while both were better than expected, reporting on a day when the market is getting heavily sold off his always tough. Holders of Telstra and Rio shares will be hoping that US traders show a more positive stance in upcoming trade so they don’t have the prospect of reporting on a negative day tomorrow. Rio will report 1H 2013 earnings as usual at the close of the market, while Telstra should announce full-year numbers before market and expectations are for a modest 1.3% growth in revenues and an 8% increase in NPAT. 

Costs will of course play into both, although Rio has already targeted $5 billion of savings over the next five years, while Telstra expects a slight increase. At an index level we feel pullbacks to 4932 (the 38.2% retracement of the 4632 to 5116 rally) look good.

On the day AUD/USD has traded in a range of 0.9000 to 0.8953 and we are keen to keep an eye on the July Taiwan export figures out in a few hours, with expectations of a 4.9% gain. Given the strong correlation with Chinese exports, a good number here could have positive ramifications for tomorrow’s Chinese export print, which in itself is expected to rebound 2% after last month’s 3.1% decline.

European markets look set to open lower, with US futures starting to creep lower as well. Corporate reporting is quite light, with Randgold and ING two of the highlights. On the data side the main game in town is the BoE’s quarterly inflation report; despite the reality of understanding exactly how definitive the bank wants to be with regards to guidance, it hasn’t really scared off sterling bulls. 

We suspect the bank will hold back from anything too aggressive and probably detail that interest rates will stay low until 2016. Our idea to be potentially long EUR/GBP from 0.8630 has got off to a good start, with the pair now trading at 0.8680. EUR/CAD also looks interesting and a closing break above the June high of 1.3817 would suggest a stronger move to 1.4150 to 1.4200. 

Cleveland Fed President Sandra Pianalto (a voter in 2014) is due to speak in mid-US trade and recall she is calling for the US to grow at 2% this year and expects the unemployment rate to stay above 7% though 2014, thus sits on the dovish side of the Fed’s position spectrum and is happy to keep the pace of purchase going.

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