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Market Insight: While We Wait for the FOMC

12/18/2013

Heading into this morning’s opening, there remains only eight-and-a-half trading sessions before the books close on 2013. I wouldn’t be surprised if trading activity over the next few sessions, before the week’s end, suggests an unofficial close to 2013. Money managers have one final major macro event to digest, this afternoon’s decision by the FOMC whether to initiate a reduction in monthly asset purchases or not.

At this point, whether tapering begins today or in March, what is most relevant will be the pace of FOMC tapering in the first half of 2014. Continued strong economic evidence like that recently reported lends itself to a steady, brisk pace for tapering, followed by at least a nine to twelve month “buffer” period before actual tightening can occur.

So while investors await this afternoon’s FOMC decision, let’s highlight some recent favorable conditions that should be considered.

  1. U.S. retail gasoline prices continue to decline

On a seasonal basis, both refinery run rates and inventories are achieving multi-year seasonal highs. Refinery operations are now running at 92.6%, the best operating levels for the month of December since 2004. Actual gasoline inventories are at 219.1 million barrels, the highest inventory supply during December since 1993. This positions the gasoline market rather favorably for the consumer both in the near term and as the peak-driving season, only six months away, approaches. Retail prices have fallen to a nearly three-year low, hovering just around $3.22 currently. All of this equates domestically to emboldened spending power for U.S. consumers and reduced input costs for select goods-providing companies.

  1. U.K. continues to be the template for developed economy growth

Earlier today, Q3 unemployment was reported in the United Kingdom at 7.35%, down from 7.61% and better than consensus estimates for an unchanged print. The 7% BOE unemployment threshold is clearly in sight and potentially attainable by mid-2014. The BOE currently has a rather accommodative monetary policy in place, with rates at 0.50% and a 375 billion pound asset purchase program. There is no better indicator of the “burgeoning recovery” than the value of the British pound (Figure 1), which has recently risen to a two-year high and has helped keep inflation in a benign position. The yield on the10-year gilt (Figure 2) remains at 2.90%, slightly below its yearly high of 3.047%, and symbolic of the growth acceleration.

  1. Signs in place for the next round of Japanese monetary and fiscal easing

It is not too soon to think about the impact from the looming April 2014 consumption tax increase in Japan. Monetary and fiscal policy makers must implement further easing measures to offset the tax. The recent resumption of the Japanese yen’s (Figure 3) downtrend is evidence that the investment community believes easing is a “sooner rather later” scenario. The yen traded to a five-year low last week at 103.92. Overnight trade figures showed an increase in exports of 18.4%, largely on the 33% increase in shipments to China. Imports surged 21.1% as domestic consumer demand intensifies ahead of the consumption tax increase. Oil imports rose a dramatic 35% and machinery imports rose 22%. Collectively, the evidence points toward further near-term easing that could possibly weaken the yen into the 105 to 110 trading range—levels not traded to since 2008.

In the wake of this afternoon’s FOMC statement, I suspect investors should first keep an eye on emerging market assets. They will have the most sensitivity to the statement in the near term.

Figure 1 British pound, 2011 to present

Source: Bloomberg

Figure 2 U.K. 10-year gilt, prior 365 days

Source: Bloomberg

Figure 3 Japanese yen, 2009-2013

Source: Bloomberg

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