Bank of Japan

The world has depended on Chinese and American stimulus for years, and, as Caixin's Andy Xie notes, one implication of their tightening is a slowing global economy in 2014.

Risk is an ever-present characteristic of life; it cannot be eliminated, it can only be masked or hedged. We know this intuitively, yet we blithely accept official assurances that risk can be eliminated by the monetary machinations of the Federal Reserve, the Central Bank of China, the Bank of Japan and the European Central Bank. To confuse masking risk with the elimination of risk is the acme of hubris and the perfect setup for disaster.

With equity markets reacting enthusiastically to the Fed’s historic policy change announced last week, PIMCO's Mohamed El-Erian notes many have rushed to declare victory. Whether in asserting investor comfort with the policy regime shift or in declaring the definitive end of dependence on quantitative easing (“QE”), they believe that the markets’ short-term reaction can indeed be extrapolated into the longer-term. While most Fed officials will welcome the markets’ favourable reaction – and especially so after the May-June shock – El-Erian suspects that they are much more cautious. Indeed, in this FT Op-Ed, he lays out four reasons why such caution is understandable.

Inflation without compensation and a consumption tax hike make a very toxic mix

A look ahead into 2014.  

Global monetary conditions remain easy and despite the Fed's decision to taper, peak monetary accommodation is not here yet.  

Overnight one of the main stories is that the European Union has been downgraded to AA+ from AAA by S&P. While the market digests the impact of the downgrade, all eyes remain on the US treasury market. As Deutsche Bank notes, treasuries are increasingly being viewed as a potential sign of the success or not of the Fed taper in early 2014. From the lows in the immediate aftermath of Wednesday’s FOMC, 10yr UST yields have added more than 10bp. Yields continue to leak this morning (-2bp to 2.95%) though we’re still hovering at levels last seen in early September just before the Fed surprised markets with its non-taper. Despite this, US equities and credit were both reasonably well supported yesterday. However the combination of higher UST yields and a stronger dollar resulted in a fairly difficult day for EM. In EMFX, the Brazilian Real fell 1.1% against the USD, underperforming most other EM currencies. The move was exacerbated by the announcement from the BCB that it would wind back its intervention in the currency market, following the initial positive reaction to tapering on Wednesday. Other EM currencies also struggled including the TRY (-0.7%), MXN (-0.7%) and IDR (-0.3%). A number of EM equity markets struggled including in Poland (-0.7%) and Turkey (-3.5%).

Although the probability of any one of the predictions coming true is low, they are deduced strategically by Saxo Bank analysts based on a feasible - if unlikely - series of market and political events. As Saxo's chief economist notes, "This isn't meant to be a pessimistic outlook. This is about critical events that could lead to change - hopefully for the better. After all, looking back through history, all changes, good or bad, are made after moments of crisis after a comprehensive failure of the old way of doing things. As things are now, global wealth and income distribution remain hugely lopsided which also has to mean that significant change is more likely than ever due to unsustainable imbalances. 2014 could and should be the year in which a mandate for change not only becomes necessary, but is also implemented."

After having followed a zero interest rate policy strategy and facing a further deteriorating economy in an environment of falling prices (deflation), the Bank of Japan (BoJ) announced the introduction of QE on 19 March 2001 and kept it in place until 9 March 2006. The BoJ chose for a very orderly and gradual unwinding of its government securities portfolio, by continuing its regular purchases of these securities (i.e a taper and not sale).  The market rejoiced at the normalization for a week or 2... before dropping 24% in the following 2 months. Of course, that was a "policy mistake"; the Fed knows this time is different.

Of the 8 "most important ever" FOMC decisions in 2013, this one is undisputedly, and without doubt, the 8th. As Jim Reid summarizes, what everyone wonders is whether today’s decision by the FOMC will have a bearing on a few last-minute Xmas presents around global financial markets. No taper and markets probably breathe a sigh of relief and the feel-good factor might turn that handheld game machine into a full-blown PS4 by Xmas day. However a taper now might just take the edge off the festivities and leave a few presents on the shelves. Given that the S&P 500 has pretty much flat-lined since early-mid November in spite of better data one would have to say that some risk of tapering has been priced in but perhaps not all of it. Alternatively if they don’t taper one would expect markets to see a pretty decent relief rally over the rest of the year. So will it be Santa or Scrooge from the Fed tonight at 2pm EST?

Key events in the week ahead with implications for early 2014.

2013 was a stellar year for stocks, but how will the markets evolve in 2014? Here is our sneak preview... 

Two phrases sum up the 'new normal' farce that is the world's equity markets in 2013... "Don't fight the Fed (or BoJ, or PBoC, or BoE)" and "Climbing the wall of worry"... one wonders, of course, what happens to 'climber' once the central bank's 'belay' is taken away (but that's just silly talk because it's all priced in, right?)...

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Presenting the countdown to Japan's D-Day.