The Tapering Game

It was a surprise for the market yesterday, when Chairman Ben Bernanke stated that the Fed will not begin to taper QE yet. The unemployment rate is still too high (7.57%) and the US recovery has not occurred as quickly as was initially anticipated. The unemployment rate must fall to 6.5%, before the Fed even considers increasing interest rates. Until then rates will remain close to zero.

Could this have been a tactical play by the FED? Yes, there was little downside in maintaining the same pace of asset purchases for a little longer. Additionally, with a new Chairman taking office Ben-bernankeimminently, it may be better for Bernanke to alleviate himself of making any drastic decisions regarding QE. The FOMC are monitoring the reaction in the market to the stated news yesterday. A 17 basis point reduction in US yields after a 160 basis point rise, from the time when potential tapering was mentioned in May, just indicates that the market still believes that the removal of QE is imminent but the question is timing.

I believe nothing will happen at the next FED meeting as monetary policy is dependent on US economic data, stipulated by the forward guidance measures the FED operates from. With little data between now and the next FED meeting on the 30th October, the Fed has little to go on in terms of their next plan of action. We could see a continuation of the same pace of QE till 2014.

Familiarity solicits a less exaggerated reaction. Thus I believe the market won’t be too quick to sell Treasuries before each subsequent FOMC meeting till the New Year.

With a continuation of US stimulus in the markets, I think the buying of high beta currencies will continue; only the disparity between buying currencies of net exporting nations and net importing nations will be more prominent. The markets will be skeptical of EM nations with low growth, high inflation and most importantly large trade deficits. We should be more selective with the high beta currencies we buy and look to buy currencies (and sell USD) of net exporting nations with heavy trade ties to China and the US instead. For example PHP, KRW and THB.

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