Tricked By A Tweet: Fed Tapering Down QE?

The markets were fairly uneventful yesterday, with no major news out during the European day. The US data (Empire State manufacturing survey and National Association of Homebuilders’ index) were much better than expected, yet Fed funds futures were not pricing in any increase in rates and the stock market was rallying nicely. Then during the New York afternoon an article appeared on the FT’s web site saying that Fed Chairman Bernanke is likely to signal that the Fed is close to “tapering down” its QE program. Although the journalist who wrote the story later sent out a tweet denying that it was a leak from Fed officials (who have a “blackout period” before meetings during which they are forbidden to talk with journalists) the message, which was more hawkish than what the Wall Street Journal had been reporting recently, caused bond yields to rise and stocks to come off their highs, while implied rates on Fed funds futures came down a basis point or two on the idea that the Fed wouldn’t raise rates even as it tapered down. The dollar weakened on risk aversion, or was it because the journalist later downplayed his own story?

As I said on May 24, I think the markets are overreacting to the likelihood of tapering off. People should remember what Fed Chairman Bernanke said back in Dec. 2008: “I made my own mistakes, but I don’t want to make someone else’s mistakes.” He said this in reference to the Fed’s error in tightening policy too soon in the 1930s, an era that he is an expert on. He may also have in the back of his mind Japan’s too-early lifting of the zero interest rate policy in 2000 and its ending of its first attempt at QE, 2001-2006, before definitively defeating deflation. Thus even if they start tapering off QE, that only means less support for the markets, not no support for the markets. Furthermore, short-term rates are likely to remain low for some time thereafter. And finally, it all depends on the economy – if the “tapering off” puts too much strain on the economy, they are likely to taper off the tapering off. In any event, yesterday’s soaring National Association of Home Builders’ (NAHB) index suggests that the housing market – the original source of all these troubles – is recovering nicely. A Deutsche Bank survey of US builders showed that mortgage rates are having little impact on housing demand even after rising 60 bps and that rates would have to rise a further 150 bps for there to be any dampening effect. It seems that the real economy can sustain higher rates even if the financial markets can’t.

Yesterday, the top administrative court in Greece defended the PM’s decision to abruptly pull the plug on the state TV, ERT. However, the court deemed that ERT should resume operations until a more efficient broadcaster is established. The three political leaders that comprise the tri-party coalition government will meet again on Wednesday to discuss the implementation of the court ruling, with a cabinet reshuffle and improvements on the coalition’s cooperation also on the agenda in order to reduce early election risks.

The G8 meeting ends today. If last year’s communique is any guide, it won’t be particularly significant for the FX market. It’s prices day in the UK and US today. UK CPI inflation is expected to accelerate on a yoy basis. The Bank of England has already said it will ignore any rise in inflation for the time being, but higher inflation combined with an improving growth picture may make the Monetary Policy Committee more hesitant to try any extraordinary easing measures – thus being GBP-supportive. In the US, May CPI is expected to accelerate slightly on a mom basis, with core CPI close enough to the Fed’s 2% target that it would not raise fears of deflation that might prevent them from tapering off. Germany’s ZEW survey is expected to show a rise in both the current situation and economic sentiment for Germany, which could support EUR/USD, although yesterday’s Bundesbank’s monthly report suggested that the German economy might slow over the summer, but that failed to move the markets – investors are focusing on central banks and only data that might affect monetary policy. Back in the US, housing starts for May are forecast to rise sharply, but building permits, a more forward looking indicator, are forecast to be down slightly. Following yesterday’s better-than-expected NAHB index, investors are likely to give the housing market the benefit of the doubt and go with the better figure.

The Market

EUR/USD
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• EUR/USD had a light trading day fluctuating within a narrow trading range with lowest tick volume in more than two weeks ahead of the start to the FOMC meeting today. The highest NY Empire State Manufacturing Index in three months hardly caused a move on the pair as the components were weak, but the dollar gained following the release of the highest NAHB Housing Market Index in more than seven years. EUR/USD rallied after the FT article was played down and found resistance at 1.3380.

• The trading range is likely to stay narrow today with notable Fibonacci support at 1.3340, 1.3320 and 1.3300. Trendline resistance may come at 1.3375 with further resistance just below the 1.3400 round number.

USD/JPY
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• USD/JPY gained on the rebounding Japanese stocks, experiencing moderate gains on the back of strong U.S. data. A tumble to 38.2% Fibonacci support came on the decreasing association of Fed tapering with interest rate increases, with a rebound to 94.90 resistance occurring today as the Topix index is gaining.

• Strong Fibonacci support comes at 94.40, with further support levels at 94.15 and 93.75. Resistance may come again at the tested levels of 94.90, 95.25 and 95.90.

USD/MXN
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• The peso came under pressure as risk-averse traders exited carry trades. It pared its losses somewhat after President Enrique Pena Nieto said he’s negotiating with lawmakers to break the state monopoly over oil and gas exploration and production this year. That would be a huge move for Mexico.

• Strong support currently comes in the 12.600 – 12.700 area that sees four notable Fibonacci levels, the 200-day MA and past trendline support. A breakdown from support sees the next notable support level at 12.440, with further 50-day MA support at 12.330 and then 12.190. Initial resistance comes at 12.900 with strong 0verlapping Fibonacci resistance seen at 13.000, with further resistance at 13.310.

Gold

• Gold had a typical day of late, trading at its 20-day MA, marginally losing on a resumption of the risk-on atmosphere that has seen notable gains for the emerging market currencies. Trendline resistance comes at $1395 with resistance thereafter at $1412. Weak pennant trendline support may be seen at $1375 with further support at $1363.

Oil

• WTI reached a four-month high reversal level of $98.65 on the political turmoil in Turkey and Syria, before retracing to $97.75, spiking to $97.40, on speculation the Fed will cut down on its stimulus. Resistance currently comes at $98.10 and $98.50, with data tomorrow expected to show a decrease in stockpiles. Fibonacci support is seen at $97.75, with trendline support at $96.95, and $96.25.

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