TradeTheNews.com Weekly Market Update: The Taper Is On
- The FOMC surprised markets and announced the taper at its December meeting on Wednesday. In the press conference after the event, Chairman Bernanke said economic growth would pick up in coming quarters but highlighted that even after the reduction in asset purchases, the Fed would still be adding to its holdings at a rapid pace. Beginning in January, the Fed will buy $75 billion in bonds each month, down from the $85 billion it had been buying since September 2012. The Fed will cut back on purchases of mortgage-backed securities and treasuries by $5 billion per month each. The Fed's assessment of the economic outlook was somewhat more upbeat and the statement was more or less in line with expectations. The VIX moved lower back toward 13 while the Dow closed the week near a new all-time high even after adjusting for inflation. On Friday, the third and final reading of Q3 US GDP came in better than the preliminary reading, rising to +4.1% from 3.6% prior, for the strongest rate of growth since the final quarter of 2011. Equities have shot higher after the taper and the GDP news, while selected decent data in Europe helped European indices gain. For the week, the DJIA rose 3.1%, the S&P500 rose 2.5% and the Nasdaq gained 2.6%.
- In the decision issued on Wednesday, the Fed said it would begin to taper QE buys in January and set qualitative conditions for the next round of tapering but left the specific details of the latter point open ended. The challenge now is managing expectations for a rate hike, and to that end the Fed strengthened its forward guidance by saying rates would remain low well after unemployment reached their 6.5% threshold. Helping matters, CPI figures released this week continued to indicate inflation levels remain below the Fed's target.
- Treasury markets were somewhat volatile as the FOMC announcement induced some recalibration. Leading up to the FOMC meeting traders were betting that at the very least tapering would be discussed extensively, even if it were not announced until next year. After the announcement traders appeared to use the news to unwind bets that the yield curve would steepen. The belly of the curve saw outsized selling which backed up yields on the 5-year and 7-year notes. Midweek offerings in those maturities were particularly disappointing, which helped the 5-year yield to reach a high of 1.72% and the 7-year to top 2.4%. Fed fund futures suggest the market believes the Fed will hike rates by the third quarter of 2015, inducing some early hand wringing that the Fed's forward guidance has not fully convinced markets yet. Spot gold hit its lowest price since June on Friday at $1,185 an ounce, closing in on a 3.5-year low touched earlier that month.
- In China, rocketing short-term rates prompted the PBoC to use short-term liquidity operations to inject emergency funding into money markets, echoing the credit crunch seen last June. In Shanghai, the seven-day repo rate rose to a six-month high of 7.6% on Friday, up from 7.06% on Thursday, while overnight interbank rates jumped to 8.2%. The PBoC injected nearly $50B into money markets to calm nerves. The Shanghai Composite fell nine straight sessions through Friday.
- Emerging-market equities plummeted this week, exacerbated by the Fed, the liquidity situation in China and a political and corruption crisis in Turkey. Turkish equities slumped after mass arrests of clients and family members of PM Tayyip Erdogan's ruling party, followed by retaliatory dismissals of police chiefs by the ruling party. The Turkish Lira fell to 2.0970 per dollar, the weakest since at least 1981. One exception was Russia, where the Micex has gained this week after President Vladimir Putin surprised everyone by pardoning Mikhail Khodorkovsky.
- The yen racked up its eighth weekly decline against the greenback after the Bank of Japan sustained its plan to add 60-70 trillion yen a year to the monetary base. The BoJ said it would maintain stimulus until annual inflation is stable at 2 percent. Most analysts anticipate the BoJ will boost stimulus after the national sales tax is raised in April. USD/JPY entered the week at 103 and rose above 104.5 on Friday.
- EUR/USD topped out last week around 1.3810, which is exactly as high as it got after the Fed announcement this week as well. Despite some decent economic reports, including the excellent ZEW and manufacturing PMI data out of Germany, EUR/USD failed to make top its 2013 highs at the 1.3830 level. Traders see more pressure on the single currency as year-end flows wind up and portfolio inflows slow down. In the UK, the ILO Unemployment Rate edged closer to BOE threshold of 7.0% while Jobless Claims declined for the 13th straight month. GBP/USD rose above 1.6350.
- There were several large M&A deals announced this week. After years of back-and-forth negotiations with various potential partners, AIG reached a deal to sell its aircraft leasing business ILFC to AerCap in a cash-and-stock deal valued at approximately $5.4B. This is the last major sale of AIG's non-core businesses in the wake of the financial crisis, which has seen the size of the firm cut in half. Semiconductor manufacturer Avago agreed to buy LSI Corporation for about $6.6B in cash, moving into the world of networking and storage chips as the computing world embraces the cloud.