TradeTheNews.com Weekly Market Update: Fed QE Prognosis Induces Market Indigestion
- Panicked investors reacted strongly to Wednesday's FOMC decision, which together with Chinese banking concerns drove an impressive global sell-off this week. Heading into the Fed rate decision many analysts were predicting a fairly dovish tone. After the decision, markets decided the Fed had outlined the beginnings of a more aggressive exit strategy and a broad array of asset classes sold off sharply with the lone exception of the United States Dollar. Government bonds, equities, ETFs and commodities plummeted on Wednesday afternoon and into Thursday before stabilizing. The handwringing on China was evident in a slow-burning liquidity crunch that jumped into high gear after the PBoC refused to provide the banking sector with additional liquidity, totally freezing up interbank lending on Thursday. For the week, the DJIA fell 1.8%, the S&P500 declined 2.1% and Nasdaq lost 1.9%.
- The Fed statement was revised to acknowledge diminished downside risks to the economy, while at the same time highlighted that inflation continues to run well below target. Updated Fed economic forecasts trimmed their forecasted range for 2013 GDP growth and called for lower 2013 unemployment and inflation. Fed Governor Bullard brought the numbers of dissenters to two, but interestingly his explanation emanated from the dovish end of the Fed spectrum. He called on the need for even more accommodative policy due to the weak inflation outlook. In the post-decision presser, Bernanke said the Fed might begin to pull back on bond-buying later this year and even end QE by next summer while emphasizing that economic data would determine the moves, and that worsening data could even lead to increased QE. He also suggested the Fed could keep short-term rates near zero even longer than previously planned, particularly if inflation stayed low.
- US Treasury yields backed up aggressively into and following the FOMC announcement. By Friday the benchmark 10-year yield tested 2.5%. Despite Bernanke's insistence that rate hikes would be far off even after the end of QE, traders are positioning themselves for a rising interest rate environment. The 10-year yield rose close to 40 basis points on the week while the early 2015 and late 2014 fed fund futures contracts sold off. These contracts are now starting to price in a Fed rate hike in early 2015 from mid-year previously. Gold prices plunged to levels not seen since early 2011 trading below $1300.
- At a government debt auction Last Friday, China was unable to sell all of the paper on offer, drawing attention to a slowly tightening funding squeeze in Chinese money markets. On the same day, data showed global capital flows into China slowed sharply in May as Beijing clamped down on speculative money inflows. This week the PBoC said it would not inject funds in order to ease liquidity conditions and overnight borrowing rates (Shibor) shot up as high as 13.4%. One PBoC official said banks were being starved of liquidity in order to make them more responsible about their lending, and another highlighted that the PBoC will not blink first in any confrontation with the banks. In the midst of the crunch, there were plenty of unconfirmed rumors of the PBoC making selective capital injections to certain banks.
- US economic data out this week was somewhat of an afterthought. Both the June Philly Fed Survey and the National Association of Realtor's May Exisiting Home Sales reports were much better than expected. The latter saw home sales jump to 5.18M units, the highest monthly rate since November 2009. A NAR economist warned that given the very strong data, "home price growth is too fast and only additional supply from new homebuilding can moderate future price growth." In China, the Flash HSBC Manufacturing PMI for June dropped to 48.3 from 49.2 in May, the lowest level in nine months. The index has now shown contraction for two straight months.
- The euro was floating up to four-month highs against the dollar above 1.3400 in the first half of the week. EUR/USD crashed two big figures to around 1.3200 in the aftermath of the Fed, and then lost another big figure as the political crisis in Greece surrounding the shutdown of public broadcaster ERT led to the withdrawl of coalition partner Democratic Left from the government. The BoJ may have been the only central bank on the planet pleased to see its currency weaken in the face of dollar strength. After finding a floor in the 94 handle and held a key 38% Fib retracement last week, USD/JPY traded as high as 98.25 in the post-Fed slide, before closing out the week around 97.75.
- Huge street protests continued in Brazil and Turkey, while crowds came out in Indonesia this week to protest the rollback of fuel subsidies. At the same time, dollar strength has punished emerging market currencies and bond yields surged. India Central Bank (RBI) said to have intervened in FX market around 59.90 after the rupee hit fresh record lows. The Polish Zloty sank to a one-year low against the euro as the cross approached 4.35. Numerous emerging market central banks took action to stem currency weakness.