Fed tapers again shrugs emerging markets

The Fed’s decision to taper by another $10 billion despite the sell-off in emerging markets reflects its improved confidence in the ability to let forward guidance stir yields lower and highlight the notion that that tapering is a normalization of policy and not a tightening of financial conditions.

The barrier to tapering has also being diminished by the 8% in yields since the December FOMC, which contrasts with the 82% spike in yields between May and the September decision to not taper.

The Fed’s desired message that “Tapering is no tightening” is reflected in bond yields’ rapid pullback. At this juncture, markets will revert to data watch, including Thursday’s release of an anticipated weak Q4 GDP, which have been impacted by the govt shutdown and adverse weather.

The next focal point from the Fed’s path to normalization will be next month’s Congressional testimony from Fed Chairman Yellen (formerly known as Humphrey Hawkins testimony), which will serve as a substitute to the absence of a February FOMC meeting in the way of communication to the market.

Unwinding euro-EM carry trade

What about the risk of renewed EM selling following the Fed’s taper? the chart below indicates the biggest decline in any emerging market currency from the peak of May 9 (the day Bernanke spooked markets with his taper speech), is the Turkish lira, South African rand and Brazilian real each near 20%. More importantly, the trade of selling euros and investing the proceeds in the carry yields of EM currencies has been unwound as seen in the euro’s recent stabilisation despite falling global equity markets. But the euro may futher benefit from the lack of any ECB easing in H1 2014.

Red-line comparison between Jan 29 Fed statement and Dec 18 statement

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