FYI | Dec 12 2013
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
Not even a strong jobs report and signs that the US Congress has reached a Budget deal two months early can get the dollar moving. In fact, any prospect of a relief rally on the back of the news from Capitol Hill were dashed when the dollar index dipped below 80.00 earlier this morning.79.90 is the low so far, while any attempts to recover have been short –lived, the high has been a paltry 80.06. So why is the dollar failing to rally?
Has the market finally got the Fed’s memo?
Although the conditions appear to be right for the Fed to start tapering asset purchases potentially in December or January, the market appears to have changed its mind about the impact of tapering. The US Overnight Index Swaps or (OIS) market, which is a good measure of market rate expectations, is not looking for rates to be raised until late 2015, and even though the November NFP report exceeded 200k, market expectations for interest hikes remained stable. This is an important development in the market’s psyche – it appears that the market is no longer thinking that tapering equals tighter monetary conditions.
At this stage, the details of a potential taper are thin on the ground. We don’t know the timing or the scale. The Fed is currently purchasing $85bn of assets a month, a taper of $10-$20 billion in the next few months would still mean the Fed is pursuing an expansionary monetary policy and its balance sheet will be rising in 2014. On a relative basis, the Fed’s balance sheet continues to expand while the ECB’s is contracting, which supports the EUR. In contrast, Japan’s expansionary monetary policy means that its balance sheet is expanding at a faster pace than the Fed’s, which is helping to boost USDJPY.
Waiting for confirmation of the Fed’s plans for 2014
Fed tapering is likely to be the start of a new era of normalising monetary policy; however this is likely to be a very long road. The market can’t really price in the impact of tapering until we know more about the Fed’s schedule. There is a chance that if the Fed does not taper in December it could use this month’s statement to detail its plans to start tapering in 2014. This is necessary as the taper story needs another catalyst to get the market moving, since everything we know so far appears to be priced in already.
A broader based “recovery” in the dollar, particularly against the EUR and GBP, may depend on further communication from the Fed on its tapering plans, thus we could be fairly range bound into next week’s FOMC meeting. This is being reflected in USDJPY after it failed to get above 103.40 highs, it is also reflected in Treasury yields, which have stalled around 2.85%. The general impact has been that there is no over-arching theme unifying the FX market, which has created some frustrating trading conditions of late.
Stocks: taper does not mean tighter
For stock markets, the taper does not mean tighter story has triggered fresh record highs in the S&P 500. Although it has retreated from these highs in recent sessions, it still looks fairly well supported. The FTSE 100 looks more rattled, as it, once again, tests key support at 6,513 – the 200-day sma. This index has under-performed its peers in the developed markets, partly because of a weak performance from gold miners and other commodity producers, which make up a chunk of the FTSE index. We believe that if the FTSE 100 breaks below the 200-day sma then it could trigger a deeper pullback in other developed market indices as we move towards the Holiday period.
Overall, the FOMC meeting is still the biggest event to watch out for before year-end, and if it yields no new taper information it could be a very quiet second half of December. But the quiet could be short lived if tempers start to rise In Washington where Congress still has to agree to raise the debt ceiling in early 2014.
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