Delayed Fed taper slams dollar, buoys emerging market currencies

Tom Tong23/Σεπ/2013Currency Updates

The Federal Open Market Committee (FOMC) decided to keep the pace of asset purchases unchanged, as what we had been expecting. However, the market was caught wrong footed, as it had priced in a modest start of the taper, i.e., cutting back purchases by $5 to $15 billion a month. Furthermore, both the new FOMC projections and the post-meeting press conference by Chairman Bernanke were more dovish than expected. Traders immediately sent the dollar sharply lower against most currencies, particularly emerging market ones that had been punished most harshly over the past few months. Asset prices also rallied, though unlike currencies their gains were largely reversed on Friday.


The publication of the minutes from the last MPC meeting clarified the Bank of England’s stand regarding the latest sign of economic strength in the UK. The vote to keep policy unchanged was unanimous. Further, unlike last month, there was no discussion of the appropriateness of market expectations for future interest rate hikes, which suggests that policymakers are not really fully committed to their forward guidance that such rates will not take place until the middle 2016. Sterling, however, took its cue mostly from the shocker across the Atlantic, largely ignoring both the minutes and the news that inflation continues to drop gently towards the BOE’s gland target. It ended up the week sharply higher against the dollar and lower against the euro.


Last week was a quiet one in terms of either policy announcements or macroeconomic news out of the eurozone. After the disappointingly weak industrial production numbers across the eurozone, next week PMI business confidence reports should provide important information about the strength of Europe’s emergence from its longest recession on record. Also, now that German elections are safely out of the way and Chancellor Merkel will enjoy a comfortable majority in the Bundestag, we expect a more realistic tack from European authorities regarding the need for yet another Greek bailout and the continuation of the other peripheral bailouts. Given the paucity of news last week, however, it is no surprise that the euro largely reacted to the news out of the Federal Reserve meeting, rallying strongly against the US dollar to end above the 1.35 level.


The FOMC decision to leave asset purchases unchanged, in line with our expectations but very much against market consensus, dominated the trading week in the United States. The member’s projection for future growth were similarly dovish, as both the central tendency and the expected range for GDP growth in 2014 and 2015 were lowered by about 0.4%. At the press conference, Chairman Bernanke justified the decision on the basis of weaker recent employment reports, the uncertain impact of the sharp rise in rates on the economy, and the upcoming debate on raising the debt ceiling and the potential for further undesirable fiscal tightening and general loss of confidence. We think that the FOMC decision to start the taper has become even more dependent on the monthly employment report, and therefore the payroll release in the United States on the first Friday of every month has clearly become the central focus of financial markets worldwide.


Written by Tom Tong

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