Market News & Insights
20 September 2013

What Next for the Fed?

EUR/USD 1.3519
GBP/USD 1.6049
GBP/EUR 1.1871 (0.8424)
EUR/CHF 1.2313
GBP/CHF 1.4618
GBP/AUD 1.6996

As the week started off with breaking US Fed related news, with Larry Summers ruling himself out as Bernanke’s replacement, and then Wednesday night’s decision by the US Fed not to start tapering its bond buying program, we thought it might be worthwhile to pause and reflect on the implications of these recent developments.

Why had the market been convinced that the Fed was going to start tapering, was it down to comments from Bernanke last June, hinting at a September. The comments certainly, however interpreted, did make reference to tapering before year end. Over the past few weeks we had hinted at a possible Octaper by the overwhelming Wall Street consensus making us amend our view, expecting a $10-15bn reduction to start this week.

The Fed may have ignored markets and chose to flex a bit of muscle as long term US interest rates were starting to run away with themselves. For example, 30-year fixed mortgage rates had jumped from 3.5% in April to around 4.5% recently. Not ideal if the Fed wants to stimulate the economy. While the Fed didn’t make any adjustments to its current stimulus program, importantly they did lower their economic forecasts. In particular, they announced another set of downward revisions for its GDP estimates for this year, which would suggest that the all isn’t as rosy in the US as surging equity markets would lead you to believe.

So where to now? The timing of events is now more crucial than ever after last weekend’s announcement by Larry Summer’s to remove himself as a candidate for the Fed Chief position. So if tapering is now potentially on hold until at least the New Year, January is when current Chairman Ben Bernanke is due to step down. At the moment, the only candidate is current Vice Chairperson, Janet Yellen. As it has been continuously highlighted in the media, she is a noted hawk and is therefore less likely to be the catalyst for speedy tapering. Currently the only alternative is for Bernanke is to extend his current term and finish the job that he started.

With the Fed postponing tapering, closer to home it looked like it would be the pound that would come out shining, however only as long as the sun is too it seems, as retail sales volumes fell 0.9 percent on the month. The Office for National Statistics said the reason for the fall in month-on-month sales came from the food sector (-2.7pc), on the back of July’s heat wave, which caused a bumper month. This release pushed Sterling lower off its recent highs against the USD albeit it is still above 1.60 USD. Versus the euro, EURGBP moved higher back above the .8400 mark. Of late, economic data had been much better than expected in the UK and yesterday’s unexpected data has put caution back into the UK economy as the BBQ seasons sizzled out. However retail sales are trending at their fastest rate since mid-2007, and with online sales up 18% and car manufacturing showing a 16% rise in August, the economy still looks set to continue its good run of form. As we know, the road to recovery is not always going to be a one way progression, and with the retail sector accounting for just under 6 percent of the British economy, we still retain our optimism for the UK growth.

Looking ahead to later today, the calendar is reasonably light with the Eurozone Consumer Confidence reading being the highlight. This may allow markets time to digest recent events but later this evening we have a number of US Fed members speaking at various events who could potentially provide clue’s as to the Fed’s rationale behind Wednesday’s events. Then over the weekend, we have the German election with Chancellor Merkel a shoe in for re-election with the composition of any coalition potentially making the most interesting reading.