Better than expected US macroeconomic data and a somewhat more hawkish perception of the Fed have increased the probability of Fed tapering on December 18. Although ING Investment Managament still believes that tapering will not start before March 2014, it is wise to assess the broader market consequences of such a move.
Markets seem to have adapted to the concept of Fed tapering. Evidence is emerging that they have ‘learned’ to understand the Fed better as they have started to appreciate the difference between tapering and tightening.
EM currencies remain vulnerable to tapering (expectations)
Probability of tapering in December has increased
A number of better than expected US macroeconomic data, combined with a somewhat more hawkish than expected Fed statement after its last meeting on 30 October has brought back speculations in the market that Fed tapering could start rather sooner than later. Although we must not be fixated too much on one month’s data, the assumption of many market pundits that corporate confidence and hiring intentions would take a hit from the government shutdown and the budget discussion does not seem to materialize.
The asset manager still believe that the tapering of the Fed’s asset purchases is more likely to commence somewhere in the first quarter of next year, also because the December meeting will coincide with the conclusion of US budget discussions, which given past precedence have a high probability of failure. Still, the odds of December tapering have increased. It is therefore crucially important to take the balance of risk surrounding our view into account. Moreover, we need to assess what the broader market consequences of such a policy move will be.
Emerging market assets remain vulnerable
Most vulnerable to tapering still are emerging market (EM) assets. As we can see in the graph on the front page, EM currencies (represented by the JP Morgan ELMI+ index) have moved largely in line with the US Treasury yield since the start of the taper talk in May. After the last Fed meeting on October 30, the Treasury yield resumed its rise while EM currencies started to weaken again after an impressive rally since early September. As EM assets have attracted so much foreign capital since the Fed and other central banks introduced their unprecedented monetary policies, they remain vulnerable to capital outflows. As with the US Treasury yield, we do not expect a sharp move comparable to the May/June period, but the risk of further weakening is likely.
You can view the complete story on the attached document.