24 Hours Later - Here's The Biggest Post-FOMC Movers
US equity markets were the first to move yesterday on the news of the tapering which is a loosening and not a tightening move by the Fed. Overnight and today has seen stocks stabilize as the rest of the world wakes up to what this slowing of flow actually means... From EM FX to precious metals to collossal flattening in the US Treasury term structure, things are making major moves...
And as a bonus, here are some just released thoughts from Goldman on Emerging Market currencies - arguably the biggest wildcard in a post-taper world:
Some EMs are adjusting, others are less clear
We have seen higher yields and weaker currencies across most of the troubled EMs; both developments accommodate economic adjustment. But not all economies are responding to these shifts in a similar way. External balances remain challenging for Turkey, Brazil, Indonesia and South Africa. Even though a temporary rally is not out of question, the ZAR, TRY, IDR and BRL remain risky currencies with scope for further depreciation. In contrast, India’s impressive current account improvement is driven both by import restraint and by export growth and, in our view, the INR is likely to remain broadly stable or even strengthen on the margin (Exhibit 3). Given this more positive view, the wide FX forwards, the elevated implied volatility and the skew towards depreciation in FX options create attractive carry opportunities in the INR. Alternatively, long INR positions can help offset the negative carry in short TRY, ZAR or BRL positions.
Equities and credit in ‘DMs of EMs’ offer better risk-reward than EM FX or bonds
From a medium-term perspective, a global backdrop where US growth accelerates, US medium-term yields rise (but gradually) and the front end is anchored at exceptionally low levels (but is subject to upside risks) should benefit equities and credit more than bonds or currencies. And, by extension, EM currencies (vs the USD) and bonds are likely to offer inferior risk-reward ratios compared with EM equities and credits (Exhibit 4). As we have argued recently, EM sovereign credit from the ‘DMs of EMs’ (those countries with the stronger institutional set-ups in the EM world) can continue to perform strongly along with US high yield credit (‘’DMs of EMs’ not underperforming significantly despite the rally’, EM Macro Daily, October 28, 2013). That said, for global investors, we still see a better balance of reward and risk in DM equities and credit relative to EM counterparts.
For now, anchored front-end DM rates should help certain ‘risky receivers’
Immediately after the September FOMC dovish surprise we argued that EM central banks were likely to respond with dovish responses. Since then, we have seen a slew of such surprises (rate cuts in Chile, Mexico, Thailand and Hungary are among the primary examples). Over the last few days we have seen dovish shifts both in Colombia and in India, while expectations for rate hikes have also moderated in Brazil.
South Africa is one of the clearest sources of opportunity in EM front ends relative to our forecasts (Exhibit 5). We expect no hikes by the SARB next year, while the FRAs are pricing in an increase in policy rates from 5% to 6.3% in one year, and to 7.3% two years from now. There is also space for Brazilian DI rates to decline towards the 10.30 area, in line with our Latam Economists’ view of one last hike of 25bp for BACEN. But unless one is ready to position for no further hikes in the near term in Brazil, the risk-reward below that level becomes less appealing. Lastly, the inverted curve in India is a result of the elevated near-term money market rate – a result of tight liquidity measures, which may be eased as the economy continues to show signs of adjustment.
But, at some point, strong US data may test the Fed’s resolve
The substantial decline in US (and by extension G3) front ends suggests that the market views the Fed’s commitment to low rates for longer as credible, given the current data flow. However, as activity picks up in 2014 (in our forecasts), there is room for periodic upside data surprises. A few months of meaningfully strong growth data could prompt the market to front-load some tightening premium (Exhibit 6). In other words, there are upside risks to front-end rates next year, stemming primarily from US data strength.
This means that bouts of EM pressure driven by US rates are likely to resurface. And the momentum in US data will determine how quickly this occurs. The uncertainty around timing makes it hard to position for such an eventuality via shorting high-carry EM instruments. Instead, low-yielding currencies from economies in need of economic adjustment, such as the THB and MYR, can offer ways to hedge against a Dollar rally vs EM, driven by higher front-end rates. In rates markets, ILS 1-year rates are pricing more than 10bp of policy rate cuts in the year ahead. Our view is that the BoI is more likely to hike by 50bp (see ‘A shift in the Bank of Israel’s ‘policy mix’ in 2014’, EM Macro Daily, December 18, 2013). Israel rates are correlated with US front-end yields and they can offer a way to hedge against such risks, earning positive carry and benefiting from local fundamental drivers that may prompt the central bank to hike next year.
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