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Market Insight: The FOMC, Morning After

12/19/2013

I find it valuable to pause in reacting to grand macro events such as yesterday’s long awaited FOMC asset purchase moderation announcement. Generally, an initial response in the minutes and hours that follow such an event are accompanied by elevated volatility. After an evening of reading yesterday’s statement, comparing the statement to others in years past and gauging the reaction of all global risk assets, a better set of expectations for risk assets can be formulated.

My first concern regarding any asset purchase tapering announcement is its effect on emerging market assets. The response for emerging market assets has been mixed but favorably absent any significant elevation in volatility.

Asian currencies have declined as expected, however, only modestly. Emerging market currencies remain the most vulnerable of the select asset classes. Emerging market debt is trading overnight better than emerging market currencies, with yields on sovereign bonds fluctuating on either side of unchanged. Lastly, emerging market equities are performing best in the wake of FOMC announcement, consistent with my expectation that equities should outperform currencies and debt in the emerging markets in 2014.

Overnight Select Emerging Market Currencies

  • South Korean won                     -0.85%
  • Malaysian ringgit                        -0.52%
  • Brazilian real                              -0.50%
  • Thai baht                                    -0.40%
  • Taiwanese dollar                        -0.38%
  • Indonesian rupiah                       -0.34%
  • Indian rupee                               -0.18%

Precious metals are weakening, as gold headed back lower to $1200, testing its June 28, 2013 three-and-a-half year low of $1179.40. Within the Q1 2014 playbook “The Search for Yield Growth,” one of the nine investment themes offered is for a Q1 continued sell-off in the precious metals that could present a near-term trough.

The yield on the 10-year U.S. Treasury has traded absent any significant volatility, as much of the “normalization” process unfolded during the summer when yields rose from 1.61% to nearly 3%. Longer-term resistance for yields rests overhead at 3.15% to 3.25%.

Lastly, the U.S. dollar at 80.533 is modestly higher, +0.54%, lifting it back toward this year’s 81.467 average. If the expected 2014 U.S. growth acceleration unfolds, the greenback might just track a similar growth-driven path as its across-the-pond peer, the British pound, has done since the summer.

The Announcement: The FOMC will initiate the tapering process by shaving $5 billion off monthly Treasury purchases, along with $5 billion of mortgage-backed security purchases, beginning in January. This will reduce the monthly asset purchase total from $85 billion to $75 billion. While the FOMC “took” from the market with one hand, it also “gave back” with the other, and inserted language to comfort markets that the outcome-based guidance for a 6.5% unemployment figure is a moving target:

“The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.”

The course to wind down the asset purchase program has now begun. My expectation is that if the expected growth acceleration in the U.S. unfolds as projected, the program will be completely wound down by the July 30, 2014 FOMC meeting. Thereafter, it would be a nine-month buffer until actual rates were raised.

2014 FOMC Meeting Schedule

  1. January 29
  2. March 19
  3. April 30
  4. June 18
  5. July 30
  6. September 17
  7. October 29
  8. December 17

FINAL THOUGHTS FOR 2013

As the final trading days for 2013 are counted down, we will deliver on the Virtus website the January capital markets calendar as well as the 70-page presentation of the Q1 2014 playbook “The Search for Yield Growth”.

I want to thank all of you who have visited the blog site this year to read our market insight and commentaries. We hope that you have found value in its content and look forward to delivering even more in 2014.

Be Long Happiness & Happiness!

Happy Holidays,

Joe

Figure 1 Spot Gold, 2009 -Present

Source: Bloomberg

Figure 2 U.S. 10-Year Treasury Yield 2013

Source: Bloomberg

Figure 3 U.S. Dollar Index 2013

Source: Bloomberg

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.