The FOMC meeting is starting today and policymakers will reveal tomorrow if they will continue to reduce the quantity of bonds and agency MBS in the asset purchase program that the Fed has been running for a bit more than a year now. Analysts/Strategists are calling for another $10bn cut, which would reduce the quantitative easing program down to $65bn and should benefit to the US Dollar (against most of the currencies).
However, we saw sharp moves in the market lately, with widespread risk aversion and position unwinds. For instance, one of the charts that we like to watch quite a bit in the morning is the US equity market (S&P500) versus AUDJPY. As you can see it, weak macroeconomic indicators starting with a Chinese HSBC PMI (Flash) falling below the 50-threshold to 49.6 in January (vs 50.3 consensus), less dovishness from the Bank of Japan and idiosyncratic drivers – Turkey and Argentina – rose risk aversion and traders started to unwind their carry trade positions and futures positions in the equity market and moved them to ‘safe-haven’ US T-Notes, Gold or even Japanese bonds and Yen (despite that Japan had at that time just posted the largest annual trade deficit at JPY 11.47tr). You can notice than AUDJPY (orange sticks) went down 4.6% between Wednesday and Friday, and the equity market dropped 56 points down to 1,790 (-3%) during the same period.
At the same time, US 10-year yield (in orange) eased from 2.87% to 2.70% and Gold (purple) surged 2.8% to 1,270 as you can see it below.
Moreover, if we quickly review the fundamentals in the US, we saw:
– A disappointing December non-farm payrolls report that printed at 74K, far below analysts’ expectations of 196K,
– A housing market losing momentum, with Existing Home sales that came out at 4.87M (lowest level since October 2012) and New home sales dropping to a seasonally adjusted and annualized 414K (vs 455K expected, biggest miss since July 2013).
In addition, we saw a March T-Bills ‘Panic-Selling’ on upcoming debt-ceiling negotiations in February, with March 16th yields surging from 1bps to 12.75bps in the last few days. Since Congress suspended the debate last October, the US Treasury has been using its assortment of emergency measures in order to delay running out of funds. However, as February is traditionally a big deficit month as tax refunds are paid out, this situation won’t last forever.
With an annual inflation rate still below the Fed’s 2/2.5-percent target range, US policymakers have no rush to decrease the amount of the asset-purchasing program and could potentially decide to stop tapering until the market stabilizes. However, we don’t think the figures and markets reactions we have seen lately are going to be enough for the Fed’s decision; therefore we are going to stick with a $10bn cut as well.