The most tenuous of these is the prospect that the Federal Reserve, which began scaling back its monthly asset purchases in December from $85bn to $75bn, will make another $10bn cut this month, according to the consensus forecast.
US unemployment has ticked down to 6.7%, which is not far from the 6.5% target purported by Mr Bernanke last year. Many ascribe this to the long-term unemployed actually giving up looking for work, which is skewing the data slightly. There is still a pledge to keep rates at record lows for the foreseeable future, too.
Lest we forget, market participants have not shown great form in predicting the machinations of the FOMC. However, the reduction was deemed bullish and viewed as a vote of confidence in the US recovery story, and thus the equity decline that was anticipated never came to fruition.
Today we are seeing 72 out of 74 analysts polled calling for another reduction in asset purchases. This has also been supported by Fed-watcher Hilsenrath, who gave the markets a heads up last time.
Ramifications in emerging markets
The capital flows from the emerging market debt market are partially a result of the FOMC monetary policy. Expectations of tighter monetary conditions in the future led to an increase in long-term US treasury yields. As returns on US bonds became more attractive, capital started flowing out of emerging markets into advanced economies. The general economic recovery and improving fundamentals are helping to spur investors’ confidence in advanced economies, which has been manifested in the ten-year yields of the most indebted peripheral markets declining significantly.
One would expect that the Federal Reserve will concern itself only with domestic issues and give little thought to the emerging market turmoil.
Reactions in currencies and commodities
EUR/USD is oscillating around the 1.3520 support level and has been capped by the 1.37 metric for the past number of sessions. Price action appears to be making another attempt to scale through this resistance.
A degree of safety has been sought by some investors as uncertainty grips. Having spent the past five weeks slowly but surely ramping higher from the $1180 level, gold prices surged to a ten-week high of $1276/oz. A stronger dollar is keeping a cap on any moves towards the $1300 metric at this juncture. This marks a strong resistance area due to the position of the 144-day moving average, which has kept the gold price in check for a full 52 weeks.
The oft-repeated phrase ‘don’t fight the Fed’ is still very much valid.