Fed Finally Announced Tapering: Dollar Rebounded, Stocks At Record High

Fed finally announced to start tapering the asset purchase program last week and outgoing chairman Bernanke noted the central bank might cut the pace of bond purchase by USD 10b in every meeting starting January. Fed also released latest economic projections which painted a better outlook for the economy. Dollar was lifted by generally positive news. The better economic outlook boosted US equities with Dow closing at another record high of 16221.14. S&P closed up at 1818.32, also a record. Treasury yields, however, didn't follow but reversed on Friday, with 30 year yield dipped to close at 3.824%. 10 year yield also closed down at 2.887%. The coming week will be shortened by holidays and we'd expect trading activities to be subdued.

In the currency markets, it should be noted that dollar was only the second best performer last week in spite of the positive news. Sterling was indeed the strongest currency, ending the week up against other major currencies. The Japanese yen was sold off broadly on BoJ expectations as well as risk appetite, but that was overshadowed by Kiwi which retreated on profit taking. While Australian dollar was pressured, it tried to stage a recovery after drawing support from 0.8847 against dollar and ended the week down against dollar and Sterling only.

To recap, The Fed announced to begin tapering its QE measures in January next year. Purchases of Treasuries and MBS will be scaled back by US$5B each. While the decision was made amid improvement of the US economy, it was accompanied with a more dovish statement as policymakers attempted to downplay the fears of stimulus reduction. Policymakers maintained the unemployment rate threshold for future rate increases at 6.5% but stressed that the fed funds rate might remain unchanged even if this target is reached. Wall Street gained as tapering was somehow priced in and as the Fed delivered a dovish statement.

S&P downgraded European Union's credit rating by one notch from AAA to AA+. The rating agency said that " the overall creditworthiness of the now 28 European Union member states has declined." And, "EU budgetary negotiations have become more contentious, signalling what we consider to be rising risks to the support of the EU from some member states." EU's economic chief Rehn responded by expressing disagreement to the assessment and that EC "disagrees with S&P that member states obligations to the budget in a stress scenario are questionable. All member states have always and also throughout the financial crisis provided their expected contributions to the budget in full and in time." On the other hand, S&P affirmed UK's AAA sovereign rating. The euro was rather unbothered by the news.

BoJ kept monetary policies unchanged as widely expected. Board members voted unanimously to keep the target of monetary base expansion at an annual pace of JPY 60T to 70T. That includes JPY 50T in JGBs with average remaining maturity of seven years, JPY 1T in ETFS, JPY 30b in J-REITs, as well as CPs and corporate bonds. In the accompanying statement, BoJ noted that the domestic economy has been "recovering moderately" with pick up in exports and business fixed investments. The economy is expected to "continue a moderate recovery as a trend". Meanwhile, with CPI at 1%, "inflation expectations appear to be rising on the whole". Kiuchi proposed again to change the 2% inflation target to a medium to long term target but was voted down by 8-1.

The BoE minutes for the December meeting unveiled that policymakers voted unanimously (9-0) to leave the Bank rate unchanged at 0.5% and the asset purchase program at 375B pound. The central bank warned that, despite stronger signs of economic recovery in recent months, appreciation of the British pound might derail growth. The BOE indicated that it would not consider rate hike until the jobless rate falls to 7% or below unless inflation soars markedly. Regarding inflation, policymakers noted that there’s no sign that it would pick up strongly as the government strived to slow a rise in home energy prices. Headline inflation is expected to ease to BOE's target of 2.0% in the first quarter of next year.

The RBA's minutes for the December meeting contained little new information from the post-meeting statement. In short, the central bank maintained a modest easing bias but the chance of further rate cut appeared low. Policymakers expected below-trend economic growth next year but acknowledged improvement in certain economic indicators. They were aware of the pickup in housing prices but shrugged off concerns of some market comments that the housing market might be forming a bubble. Policymakers in general also remained concerned about the strength of Australian dollar.

As for trading strategies, our buy on break in the EUR/USD and sell on break in the EUR/JPY were not triggered last week. We'd prefer to hold our hands in this holiday shortened week and spend some time away from the markets. Wish our readers happy holidays!