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Fed Tapering Is A Threat To Risky Assets & Emerging Markets – Dec 23-27

December 22, 2013

Bernanke fulfilled his June 19 commitment to begin taper of its bond purchase by end of this year if the economy continues to improve. Interesting since then until FED’s December 18 announcement, there was fierce discussion/battle between the Hawks and the Doves on the tapering subject with Doves mostly vocal and forceful and demanding considering delaying, as they were not convinced about consistent US economic performance and saw risk to the economy. Hawks were not as aggressive and in the end proved to be correct in their assessment about economic gains, as FED has announced to begin scaling down of its bond purchase from January 2014, though in small amounts.
There was a reason for Doves to be too vocal on the subject that may have helped to consider small cut in bond purchase. Dove’s supporters, other than FED members are basically the elite borrowers that have the excess to borrow and have been enjoying hefty profit against cheap funding facility made available to them since last over 5-years that did not benefit the economy as per expectation. Instead last week it had put FED in more awkward position by inflating the size of balance sheet to USD 4 Trillion that will continue to increase in size unless monetary stimulus completely halts. It will never be easy to shrink FED Balance Sheet.
So far financial market did not react to the tapering news that will become effective next month. FED announcing that it will start tapering its stimulus means that it ultimately plans to deviate from its unconventional methods and hence, market will begin to perform in line with the economic fundamentals and here lies the big challenge, when injection of liquidity is reduced and then totally stopped.
Tapering will surely impact risky assets due to position adjustments. It is bad news for the Bond market, as rising yield will also hit all income related instruments. This can especially bring shockwaves for the emerging market and its bond market could badly suffer. It will also lead to unwinding of all carry trade businesses.
During extremely easy monetary policy stance, there is one large segment of the society in majority that suffers most for wrong reason and they are savers that have to subsidize government borrowings and have to pass on the benefit to business community. But unwinding of Treasury Bonds will surely bring relief for the savers in a hope that they will soon get relief from negative return.
Though in coming days/weeks/month’s market will be watching FED stance and the language used for future guidance, but the financial market will start concentrating towards economic performance that will be based on fundamentals. Since FED’s forward guidance has provided clear indication that its policy rate will remain close to present levels for next couple of years. Hence, market will be more focused on yield curves, as risk of low inflation and tapering means steepening of curve or increasing of gap between short-term against long-term treasury instruments. Availability of liquidity will be another key factor that will play major role to determine future market direction.

GOLD @ 1202.65 = Before I make a comment on gold, one thing is for sure that we are heading for a choppy year end due to holiday season, thin market condition and year end closing. Desperate bears will make every effort to push gold higher, but I consider such up move as opportunity to sell, as gold has no major fundamental and economic support to trade at higher levels. Last week gold made perfect move in line of my forecast to cap below $ 1240 to breaching my weekly target $ 1193 briefly before inching up towards $ 1202.
This week a similar move is expected, but I am expecting fall to extend if holds below $ 1215-20 levels or else gold could move towards $ 1235-40 zones. It needs to fall below $ 1185 for a test of $ 1170-72, with $ 1148 another important support level.
EURO @ 1.3669 = The current strength of European currency is largely based on extraordinary economic performance by the Germany that countered S & P downgrading of European Union, which consists of 28 member states, as most of them has weak credit conditions. Euro neither succumbs to strong US GDP data. The other big factor supporting Euro is large maturities of LTRO, which is draining of liquidity from the European Banking System helped to reduce the size of ECB balance sheet. Overall it has been a good mix for the currency to maintain its continued strength.
This week Euro will have to move beyond 1.3720 for 1.3775. However, Euro may find selling interest on the up and on the downside needs to break 1.3610 for a test of crucial support level of 1.3570-80, but will find buying interest on dip. This is why European currency is likely to trade in a narrow range 1.3540. Range for the week 1.3520 – 1.3810.
GBP @ 1.6327 = Signs of robust UK growth is obvious though recent manufacturing data and deficit showed some hint of slowdown. Overall mood remains Bullish, despite BOE showing discomfort with strong currency was taken seriously by the market. Unless there is more bad news for Cable it will find buying interest on dips.
The levels to watch is 1.6250-70, which may hold for another upside or could 1.6180 levels before up. However, a move beyond 1.6380 may encourage for another test of 1.6220-50 zones. Range for week 1.6180-1.6450.
JPY @ 104.07 = JPY could move to test 104.50-60 zones, but suspect Japanese currency will weaken beyond 105. A move toward 103.20 could be a possibility on break of 103.70. Range for the week 102.50 – 104.98.
AUD @ 0.8919 = Aussie may find temporary floor around 0.8820-50 and only break of this level risks for 0.8750. Break of 0.8809-90 will pave way for 0.9040-50 before correction is over. Range for the week 0.8750-0.9080.

Dec 11 -Gold 2014 Target  Break of $ 1000 for $ 800.

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