Known to be the most dovish man in the world, in the last FOMC press conference, Ben Bernanke acknowledged that downside risks have diminished in the US and there is further improvement in the labour market. The FED’s economic projections showed growth in-line to slightly higher and a lower jobless rate forecast. Markets took these comments as a signal that with this kind of improvements, there is no way that the Fed could continue the largest accommodation program the world has ever known. Automatically, selling pressure started to hit every single market with the bond market coming under consistent and intense pressure.
While it started with the bond market, the movement translated into dollar strength across the board with emerging markets coming under intense pressure whether from equity to bond and currency markets.
In summary, the main message from the Fed speech this week was a change in tone to portray a hawkish Fed, as the entire debate shifted from the timing of QE tapering to the timing of QE exit. In addition, while the FOMC statement continues to highlight the potential for QE to be adjusted up or down, the Chairman’s press conference was all about expectations of a QE wind-down.
On the foreign exchange side, currencies closed the week with a stronger dollar across the board with the main victims emerging markets currencies. After falling all week up to Wednesday night, the Dollar index received a boost from the Fed meeting to close the week at the high of 82.50.
The euro was very well supported at the beginning of the week, reaching a high over 1.3400 levels; however, the currency ran out of steam and broke down after the FOMC meeting to close the week at 1.3122 following a stronger USD against all the majors.
The Sterling Pound held firm at the 1.5600 levels, helped by an unwinding of Sterling funded carry trades; however, the reaction was fairly muted. After reaching a high of 1.5752 on Monday, the Pound ended the week at 1.5419.
The Japanese yen dropped by over four percent during the week on stronger USD and on comments from Japan central bank governor that uncertainty surrounding Japan’s economy remained high; however, the country’s exports have started to pick up with support from the currency moves. The yen closed the week with 10 points shy of 98.00.
In the commodity complex, gold prices tumbled again mainly on continuing unwind of carry trades and a hawkish Federal Reserve. As confusion over the Fed policy continues, investors are attempting to price a potential exit of QE from the Fed. Gold prices closed the week below the $1,300 level.
After getting support from the political turmoil in the Middle East, oil prices succumbed to the global selling pressure and ended the week at $95.60.
The Chairman of the Fed, Ben Bernanke, tried to provide some comfort to the bond market but the hope lasted only seconds into his speech, as 10 years yield moved from 2.18 percent to over 2.42 percent by the end of the week. The FOMC statement noted downside economic risk had diminished and labour market showed further improvement in the economy. Investors took these signs as the Fed could be preparing for tapering in the second part of the year but Bernanke tried to limit the impact by suggesting tapering would not be over until mid 2014.
Bernanke downplayed the triggers on hitting economic targets. “The economic conditions we have set out as preceding any future rate increase are thresholds, not triggers.” In addition, “increases in the target for the federal funds rate, once they begin, are likely to be gradual”.
The market ignored these comments as he added that if the economy performed more strongly, the pace of the taper could become more aggressive. According to analysts, under the Fed’s scenario, the rate of purchases would change from $85bn later this year to zero by mid-year 2014.
The latest US Empire Manufacturing survey came much stronger than expected and the national association of Homebuilders numbers impressed markets, as it seems that homebuyers were insensitive to a potential increase of interest rates. The headline component of the NY Empire survey was as mentioned stronger +7.8 vs -1.4 previously. However, the underlying details showed a broad-based deterioration. Aside from the inflation components, every underlying component deteriorated, including new orders, shipments, unfilled orders, delivery times, inventories, employment and the average workweek. On the other hand, the general business conditions in the survey indicated that conditions had improved modestly.
Europe & UK
Markets continue ignoring all European headlines as all attention is turned to the economic situation in the US and China. Indeed, headlines coming out of Europe this week, whether about Cyprus protesting their package or Greece being late on the Troika commitments, were ignored and the euro continued to be well sustained when compared to the other currencies. Indeed, in a letter addressed to eurozone leaders, Cyprus’ president has asked for a complete revamp of his country €10bn bailout package and warned that Nicosia may not be able to meet the rescue’s current terms because it has harmed the country’s economy and banking system even more than expected. Also, reports that the IMF may suspend aid payments to Greece unless the bailout hole is plugged, did not get any traction from the market.
The Greek bailout, Cyprus restructuring of its banking system along the refusal of the ECB to embark into unconventional monetary policies signalled that all Euro funded carry trades should be unwounded and gave a boost for the currency against all its peers. As global markets were shocked by a potential end of the cheap money syndrome, the Euro has been supported on the back of the deleveraging/unwind of carry trade.
The Peninsula
