Ahead of a historic day

There’s been lots of debate over what could possibly happen tomorrow and the market activity which could follow.

We can agree on one thing; we could use more information from the Fed in regard to where they see US economic growth and inflation, and how they will wind down the government bond-buying program. The focus will be on the language they use and the message they try to get across. It has been five years since the financial crisis and a recession.

The US economy is no doubt in a better place than it was before. Yet, the effectiveness of the QE program is being questioned. US economic growth at this stage of the recovery should show better data points, such as a higher annual GDP growth rate than 2% and a lower unemployment rate than the 7.3%. The participation rate, which is the number of Americans looking for a job or in a job, is at 63%, a 35-year low.

Digging deeper

Digging deeper into these numbers would reveal a bleaker picture, with 37% of people jobless for more than six months, 90 million people no longer in the workforce and youth unemployment at 16%. This means that if the data were to consider those who dropped out of the labour force, the unemployment rate would be higher. Surely this is not what we expect to see in an economy that is recovering, which is one of the reasons the Fed might delay tapering tomorrow.

The markets will react to whatever happens tomorrow. They have been waiting for four months, since the Fed first laid out the plan for a QE response. 10-year Treasury yields have been pricing in this moment, rising from May’s 1.63% to 3% last week. Stocks, on the other hand, have touched all-time highs in August, when the S&P 500 closed above 1709 before retreating 3% over the summer. In September, it made its recovery and yesterday’s close was just 5 points shy of 1709.

Shifting focus

Working on the premise that the Fed does start winding down tomorrow, we can expect investors to shift their focus back to the norm - fundamentals and projected earnings growth. US earnings have been relatively strong in Q2 and Q3, while there were concerns about the quality of growth in emerging Asian markets.

The driver of emerging Asian markets will be closely correlated to the global economic growth and their trade partners. What’s stood out has been the strong recovery of emerging Asian currencies this month. Unsurprisingly, the worst performers – the rupee and rupiah – led the gains. It is a reflection of how investors have come to acclimate to the Fed’s actions.

The expectation is that a smooth and gradual process is likely to take place, with rates to remain low for an extended period.

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