Could we survive without QE? (Part II with US yields)

Last month, we wrote an article that summarized all the decision made by the US policymakers since GFC and the impacts as soon as the central bank was stepping out of the market (see article Could we survive without QE?)

We concluded that as soon as the Fed was ‘leaving’ the equity market and let it rely on fundamentals only, we saw sharp correction straight afterwards (See chart below: April—July 2010, July – August 2011, September-November 2012).

SP10Oct(1)

(Source: Reuters)

As we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bond’s market at the end of this month (October 28th), we thought it is a good time to give you an update on the current situation. And Guess what: this time is not different. Since the mid-September high of 2,019.26 (Sep 19th), the S&P 500 is down 7 percent and closed for the second consecutive session below the 200-SMA for the first time since November 2012. And the question we are asking ourself is: how far it could go? We don’t have a specific answer to that, but what we can tell you is that the Fed’s Officials are now realizing their mistake by expressing themselves on their ST monetary policy. Our thoughts have always been that Yellen [& Co.] should have let the market swallow a period without QE before considering raising its ST interest rate. Therefore, we saw at the last minutes (last Wednesday) a different tone, with policymakers suddenly jawboning about the US Dollar Strength (Yes, even the Fed is not comfortable with a strong exchange rate) and the fact that global slowdown could rise risks to US outlook. We expect the tone to remain neutral until the end of the year, therefore capping the appreciation of the US Dollar against all currencies. If the equity market continues to tumble, we think we can even see/hear a couple of dovish statements/conferences as the equity market is one of the most important index (with oil) for US policymakers.

If we have a look at the LT interest rates, the 10-year US yield is now trading at its 18-month low at 2.20%. Clearly, that shows the situation in the market is much more fragile than expected. Moreover, we added a similar chart as the S&P 500 but this time applied to the 10-year yield. We read and heard analysts’ recommendations on yields, and most of them are quiet bearish on Treasuries in the next months to come, targeting a 10-year yield at 3%. However, if we look at the chart below, we can see that each time the Fed stepped back of the bond market, LT yields contracted (March – November 2010, July-September 2011). And it looks like this time is [also] not different with the 10-year yield down 80bps since December’s Taper Announcement.

10Year(1)

(Source: Reuters)

Happy October: End of POMO

As October is the Fed’s POMO – Permanent Open Market Operations – last month (as it is mine in Hambros), we will see how the equity market will deal in a period with no QE. The NY Fed released yesterday its purchase operations for the month of October (as you can see it below), stating that the central bank will buy approximately $10bn worth of Treasury securities on an outright basis.

Starting October 28th (the first day of the next FOMC meeting), the equity bulls will start to rely on fundamentals once again. As we say, will this time be different?

20140830_POMO_0(1)

(Source: NY Fed)

The market has switched to a risk-off mode for the past couple of weeks with the S&P 500 struggling to trade above the 2,000 level. As you can see it on the chart below, the index (purple line)  is down 2.2% from its September’s high of 2,018.21 (Sep 19th) and AUD/JPY (black bar) is back below the 96.00 level (down 2% as well) and has been fluctuating within a 100-pip range for the past week.

 AUDJPY-01Oct(1)

(Source: Reuters)

Earlier this morning, both Germany and UK released a lower than expected manufacturing PMI, coming in at 49.9 (vs 50.3 expected) and 51.6 respectively (vs 52.5 expected). France reported its budget deficit forecasts for the next few years, and the government sees deficit falling to 4.3% of GDP in 2015 (from 4.4% this year), 3.8% in 2016 and eventually somewhere below  the 3% threshold in 2017 (optimistic?).

EUR/USD was little sold this morning after the macro news (1.2584 is today’s low) and is now trading back above the 1.2600 level. Cable hit its 1.6160 support, the 76.4% Fibo retracement of 1.6050 – 1.6526 (as we reported yesterday) before coming back to 1.6200.

GBP01Oct(1)

(Source: Reuters)

This afternoon, the market will watch West fundamentals with Mortgage Applications, ISM Mfg PMI and ADP National Employment  in the US and Canadian PMI. We don’t see any major developments in the FX market as the market is now focused on tomorrow’s ECB meeting and Friday’s NFP.