A Key Lesson For The Coming Week And Beyond
The following is a partial summary of the conclusions from the fxempire.com weekly analysts' meeting in which we share thoughts and conclusions about the weekly outlook for global equities, currencies, and commodity markets.
The Short Version
It's unlikely that there will be any material cuts in QE any time in the coming months. Yes, a symbolic, insignificant cut could come and even that could spark some wicked countertrend moves for stocks, the EURUSD, the USD, etc. View them as temporary opportunities to buy stocks and other risk assets and sell the USD.
Why? We don't have the data the Fed will need to justify a real taper. We're still lacking sufficient evidence of sustained growth of any kind, never mind growth that could withstand speculative spikes in rates like we saw following the early taper speculation. We're not likely to see such sunny data any time soon.
That said, the past week's reaction to a fundamentally dovish FOMC statement as if it were hawkish suggests that markets remain vulnerable to any hints of tapering and, as we noted here last week, will likely continue to move with speculation about QE. Meaning, markets continue to function in "good news is bad and bad news is good mode." Risk assets will continue to respond best to news that is either mildly positive or negative, as both types mean QE stays put.
If you want specifics, keep reading. You just got the conclusion.
That data is unlikely to provide enough sustained improvement to allow the Fed a sustained, material cut in stimulus. Granted, with markets at historical highs without the support of equally sunny growth and earnings, they are extremely sensitive to even small risks of QE cuts, as recent months, and last week, so well demonstrate. Thus even a symbolic cut before year-end, or the rising risk of it, could well be enough to spark a reversal of the past year's bullish trends in stocks and other risk assets like the EURUSD, and in the USD's downtrend.
However for any sustained QE pullback the cautious Fed will need sustained signs of growth. Currently that seems unlikely.
Essentially in line, but struggling to grow top line revenues needed to suggest sustainable growth. Not bad, but hardly the stuff we'd expect with markets at all-time highs.
Also not the stuff we'd expect to see at all-time highs. There have been some bright spots (US and Asian manufacturing) but overall, hardly a bright picture that would encourage a dovish, cautious fed to start curtailing it bond purchases. Just a few recent examples:
- Retail Sales were soft. That does not bode well for a consumer-based economy. See here for details
- Jobs: Last week's ADP non-farms payroll was ugly, and ADP has not varied much from the official BLS figures. See here again for details.
- GDP: The consensus is 1.9%, below the 2.0% minimum believed needed to avoid recession
- Inflation: This remains quiet. For example last week PPI fell 0.1% vs. an expected increase of 0.2%. No inflationary pressure.
- Pending home sales down 5.6% in September
3. Fed In Transition Discourages Policy Changes Until Bernanke Departs
The December and January FOMC meetings will be Bernanke's last. It's unlikely that he would make a major policy shift to begin tapering and leave it his successor to deal with consequences.
4. Past And Future US Budget Battles
The spending bill and debt-ceiling crisis was merely deferred to January and February. The Fed has admitted its concern over how Congress's worrisome performance would influenced its "no taper" decision at its September meeting.
Given the above, it's unlikely we see any material taper until well into 2014 at earliest.
Symbolic Taper in March Can't Be Ruled Out…If Fed Thinks It Can Avoid Spiking Rates
As noted here, changes in foreign demand for US bonds and in US funding requirements could allow the Fed to cut about $20 bln/ month of its $85 bln/month QE program without any net reduction in stimulus. That $20 bln would look like an almost 25% cut, and so provide a symbolic start that would dampen some of the speculative rise in stocks and other risk assets. Yet if markets got really nervous, the fed could argue that little had really changed, without needing to back down.
The big caveat risk to even that, as we discussed last week here (regarding Richard Koo's "QE Trap), is that the Fed could cause an interest rate spike based on sheer speculation, and so risks neutralizing the recovery
Ramifications: Markets To Remain Hypersensitive To Anything Influencing Taper Speculation
What was it that caused markets to raise the taper risk level? Not much.
- The FOMC statement said that the Federal Reserve is not worried about the sluggish pace of job growth - instead it feels that labor market conditions have improved. It didn't mention the recent disappointments in non-farm payrolls or the chances of weaker job growth in October.
-More significantly, the central bank is no longer worried about tighter financial conditions, which could have slowed the recovery. With stocks rallying and bond yields falling, financial market conditions have improved, thus easing the fed's immediate concerns about higher mortgage rates.
- The Fed did not say that tapering should be postponed until 2014. Instead it said they'll continue monitoring incoming data and then decide whether to adjust asset purchases. THAT omission led some investors to believe that asset purchases could still be reduced this year
Be it data or fed officials' comments, anything that materially influences sentiment on the timing and pace of a QE taper will likely be market moving. As noted above, we don't think growth will be good enough to justify a material change, although a symbolic start cannot be ruled out.
That alone could spark a taper tantrum, until markets really it's no biggie. If so….
How To Profit
Barring any sudden sustained improvement in US data, see any spikes in QE taper fears as noise, temporary market misreads of reality from which you can profit. See the selloffs in stocks (SPY, QQQQ) or other risk assets like the EURUSD (FXE, UUP, UDN, ERO, etc.) or other anti-dollar plays like gold, as buying opportunities.
Don't take my word for it; you can rely on far bigger authorities than I, such as Jeff Gundlach, the reigning bond deity.
Meanwhile, the taper keeps the USD in its long term downtrend against, well, almost every major asset hard asset and currency. For those with most of their assets linked to the fate of the USD, see here or here for a collection of safer, simpler ways to diversify out of the USD. Highly recommended for those based in EUR, JPY, or GBP.
See here for the rest of our articles on lessons and outlook for the coming week.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.