Prospects for Fed "tapering" sink bonds, some emerging market FX

Tom Tong03/Jun/2013Currency Updates

We are now seeing worldwide what is essentially a dry run for the withdrawal of extreme liquidity support from the Federal Reserve. As we have been predicting for some months, the US economy is maintaining moderate growth and job creation. Consequently, Federal reserve officials are hinting to an upcoming “tapering” of additional bond purchases as early as this summer. This prospect is driving the violent back up in yields in bond markets worldwide. Particularly hit are US Treasuries and the more marginal fixed-income instruments that had benefited from the “chase-for-yield” efforts brought on by QE. While commodities and equities are holding up well, FX markets are being hit by a round of deleveraging. These deleveraging moves are particularly dramatic in those currencies which had been treated as one-way bets, such as the Yen, as well as some of the higher-yielding emerging market currencies with negative current account dynamics, like AUD, NZD and, notably, ZAR.

We expect the volatility to continue in those currency pairs most exposed to sudden changes in investors perception and positioning. In addition to JPY, AUD, NZD and ZAR mentioned above, we’d watch very carefully moves in IDR, INR, BRL and MXN. This week is packed with event risk, as no fewer than four major central banks meet (ECB, Bank of England, Banxico, and Reserve Bank of Australia), PMIs come out in most developed economies, and US payrolls will cap the week on Friday.


There were no first-tier macroeconomic releases or policy surprises in the UK last week. The main exception was the CBI retail survey, which weakened slightly to -11 in May; it confirmed the message from the BRC survey, which is also pointing to sliding consumer demand. Sterling had a rather quiet week, moving in a very tight range of +/-0.3% against the Euro and tracing the common currency slightly higher against the dollar. We expect volatility to return to GBP this week, as traders and investors digest central bank meetings, PMI numbers and US payrolls.


May inflation data provided further evidence of the complete absence of inflationary pressures in the Eurozone as a whole. Headline inflation is now 1.4%, and core inflation ticked down further to 1.2%. This should bring more pressure to bear on the ECB to announce further reflationary measures at its monthly meeting on Thursday; not only is the economy stuck in perma-cession, but inflation numbers are moving well below its target of “close to, but just below 2%” and closing in on deflation. In spite of the ECB’s effort to talk down expectations regarding SME-oriented policy easing, we expect that events will force the ECB hand and that it will announce significant progress in the SME-easing front, as well as more visibility regarding the possibility of negative rates.


Friday’s release of the non-farm payroll report in the US is shaping up as the most critical macroeconomic news in quite some time. Markets are completely focused on the expected timing for the tapering off of QE, and this in turn is thoroughly dependent on the evolution of the labour market, given the complete absence of inflationary pressures. The trend for the past six months has been slightly above 200,000 jobs per month, and a gently descending unemployment rate. Another report like that would lead investors to price in that the so called taper of QE will start in late summer, and will likely lead to strong moves upwards in yields, and continued leveraging out of higher-yielding EM currencies. Soon after the payroll report comes out, Ebury will put out an analysis of the number and its likely implications for financial and FX markets.


Written by Tom Tong

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