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The FOMC will taper in the short term however it has left the door ajar to retract the timeline and increase QE if things deteriorate.
So where does this leave the globe? The FOMC sees QE ending by mid-2014, and agree that ‘downside risks to the outlook for the economy and the labour market have diminished since the autumn’.
We agree with this statement - the US labour market is nearly there, currently averaging just under 200,000 jobs added every month since December last year; building approvals and construction is well and truly on the way up and consumer sentiment is hitting levels not seen since pre-GFC.
The tapering timeline is interesting - most had expected it to start in October according to a survey conducted by Bloomberg, however Ben Bernanke’s statement states:
‘If the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchase in measured steps through the first half of next year, ending purchases around mid-year’.
Which begs the question, why did the markets react so violently to his statements? It is this part of the statement that seems to be getting the most air time: ‘The Fed may “moderate” its pace of bond purchases later this year and may end them around mid-2014’.
A case is now being mounted for tapering to begin in September. The statement was constantly justifying the comments made in the last two meetings in particular - that QE should end. The market consensus is that the first taper will be around US$15 billion - taking the purchasing programme from $85 billion to $70 billion. This certainly looks like the market’s interpretation.
The Dow and S&P both dropped like a stone on the news, falling over 1% in the last two hours of trade. AUD/USD was the deer in the headlights; losing over two full cents (-3%) from the high just before the announcement to $0.924. To equate this in stock terms, this fall would be like a stock losing 15%. Gold also plunged as the store of value appears less and less appealing.
However, the statement as a whole should be seen as broadly supportive of the markets. Growth forecasts were upgraded (which is why the USD is now an investment currency), rates look like holding at near zero till at least 2015 (which is a supportive monetary stance and will remain separate of the purchasing programme) and it is going to retain the mortgage backed securities purchased during QE on the balance sheet till expiry (this information was unknown until last night) - all very supportive.
However, the market was never going to enjoy hearing that the ‘liquidity-support’ it has enjoyed for the last three and a half years was going to end and, ahead of the open today, we are calling the ASX 200 down 42 points to 4815 (-0.87%). It could fall further than this as the carry trade continue to unwind. We would expect the banks to take the biggest hit having rallied nicely since last Thursday. BHP’s ADR is suggesting the security will lose 24 cents (-0.72%) down to $32.73, even with iron ore prices continuing to move higher by 2.3% up to US$120 a tonne (taking the current rally 9.09% since hitting a year-to-date low of $110 a tonne).
Today will be a very interesting positioning day - the markets will enjoy punishing top heavy stocks as the carry trade unwinds, profits are locked in and rates are moving higher. It will be a very tough day to be a bottom up investor.