FOMC Supports Emerging Markets
On Wednesday afternoon, September 18, the Federal Open Market Committee (FOMC) released its post-meeting statement absent of any asset purchase moderation. For much of the third quarter, my expectation was that, in fact, the FOMC would moderate from its current $85 billion in monthly purchases of U.S. Treasuries and mortgage-related securities by $10 billion, specifically relative to Treasuries. Additionally, I expected the outcome-based guidance for the unemployment rate to be lowered from 6.5% to 6.0%. Yesterday’s announcement proved those expectations incorrect.
Aligned with those expectations is the belief that both here in the U.S., and to a lesser extent globally, a modest economic recovery is underway. Throughout 2013 I have maintained that investors continually be allocated toward risk assets as those favorable economic tailwinds emerge.
My belief that a modest recovery is underway has not changed based on the current evidence. In the U.S., housing, auto, energy, and the services components of the economy are all signaling strength. Manufacturing, which has lagged over the prior 12 months, is also recovering in the U.S., as well as in Europe and China.
So what exactly gave the FOMC pause? Overall, in terms of allocating toward risk assets, the reasoning for the pause really doesn’t matter…rather, the outcome does. By 4 p.m. yesterday, the S&P 500® Index (SPX) (Figure 1) closed at an all-time high of 1725.52. However, there was some interesting price action that warrants determining both the FOMC’s motivation and impact on select markets.
On the surface, the Fed Chairman offered concern in his press conference that fiscal conditions had tightened and threatened the budding recovery. He also suggested that fiscal policy headwinds were a threat to the recovery. However, I suspect the true motivation for the Fed holding back was not stated by the FOMC or the Chairman at all – in fact, the Fed held back due to significant concerns over further emerging market economic, currency, and credit market deterioration.
Clearly, the FOMC would never acknowledge factoring in the effect of bond purchase tapering on the emerging markets. St. Louis Fed President James Bullard recently stated, "We are not going to make policy based on emerging market volatility alone." However, I suspect they did exactly that!
Think back for a second to the Fed’s Jackson Hole economic summit at the end of August. Intense pressure and finger pointing was directed at the U.S. by the IMF, Brazilian central banker Alexandre Tombini, and Mexican central banker Agustin Carstens. The Chinese also warned of the impact U.S. policy tightening would have on domestic Chinese growth. Also, think back to when the MSCI Emerging Markets Index (MXEF) (Figure 2) traced out a double bottom low for 2013 on August 28 – just days after the Jackson Hole summit concluded.
In the early days of September, intense buying and a surge in volume followed for emerging market equities and currencies. At the G-20 meeting, while the mainstream media focused on U.S. and Russian negotiations on Syria, other attendees very quietly focused on the troubles emanating from the currencies and credit markets of the emerging markets. In fact, there was chatter about potential capital constraints being placed on select emerging markets. I view that as rather difficult to achieve but it was privately discussed.
I think it is important to understand what potentially occurred yesterday. Quite possibly, the "Bernanke put" went global to try and support the emerging markets in the near term. However, I do not believe this creates a renewed environment in which "all boats will rise."
Select emerging market economies such as South Korea, Mexico, and possibly China, most likely have traced out their lows for 2013. Unfortunately, other emerging markets such as Brazil and Turkey, to name two, remain vulnerable. Investors over the past few weeks have been buying emerging market equities and currencies to a much lesser extent than emerging market debt. That lack of buying interest in the debt markets underscores some of the fiscal imbalances that select emerging markets are challenged by.
Gold (Figure 3) rallied yesterday also. Recently I stated that I believe both the high and low for the precious metal has been established in 2013. Therefore, I view yesterday’s precious metals price action as non-actionable.
Overall, I still expect the FOMC will begin tapering based on an improving economic outlook, quite possibly as soon as its next meeting on October 29 and 30. Domestic cyclical and specifically energy assets remain my most favored investments. I do not expect this week’s FOMC surprise will resurrect the “search for yield” theme where investors flock to bond-like assets.
Most probably today was an acknowledgement that while on a tactical cyclical basis the emerging markets are in a challenged position, structurally their prominence on the global stage cannot be ignored.
Figure 1 S&P 500 Index (SPX), September 2012 to September 2013
Figure 2 MSCI Emerging Markets Index (MXEF), September 2012 to September 2013
Figure 3 Spot Gold, 2013