Reality on, risk off. The era of free money printing may finally be coming to a closure in the United States. With the Fed's intention of scaling back on asset purchases by year end and ending QE programs mid 2014, the markets could be in for a volatile ride the next few months. Lets break down the current state of the market.
The United States was the first G7 country to initiate programs of money printing at will during the financial crisis. It comes as no surprise that they are the first to formally announce plans of an exit from this strategy. On the other side of the world, levels of economic uncertainty remain high for the Asian/European countries and it is unlikely that they will diverge from current policies in the near term. Whether you look at it from a supply/demand context or a market sentiment point of view, the value of the USD will potentially see a significant increase as a result of this policy shift.
Specifically, I am projecting a major move in USD/JPY to the upside. Despite the recent 'concerns' from participating members, the BoJ may not be able to afford changing course on the 2 year distribution of its recent stimulus package . Furthermore, there have been talks of potentially increasing the amount of accommodations which would only fuel further weakness in the Yen.
Whether the Fed will actually follow through with their plans in the next 6-12 months seem irrelevant at this point as global markets have been reacting sharply with no restrain. Precious metals are down over 5% while bond yields are spiking across the board. Liquidity issues coming out of China last night only worsens the situation as yields on government bonds jumped 39 bps to the highest level since its issuance. Equities drove deep into the red overnight and US equities have opened over 1% to the downside signaling a continuation of the sell-off.
I would mark yesterday's event as an inflection point in recent market trends and will look for a continuation of Dollar strength at an accelerated pace with significant levels of volatility to come.