Surprising move from the FED saw a reduction of QE by $10bln starting January

Tom Tong19/Dec/2013Currency Updates

GBP

Sterling skyrocketed yesterday, peaking across the board following labour market data smashing expectations. Furthermore, we saw a nice rally in UK stocks with the FTSE uppercutting gains after trading flat for the past few days. London closed with pound gains across the board most notably against the greenback. The market opened with sterling well supported and traders will hope that today’s UK data releases mirror yesterday’s good news.

Naturally, the market focus was on UK employment figures, which surprised to the upside hence the sterling rally. Specifically, the number of people out of work has nosedived to its lowest level in 4 years. The jobless rate dropped 99,000 to 2.39mln. Therefore overall unemployment now sits at 7.4%. Furthermore, the total number in work is 30mln which is encouraging as this is the highest number ever. The ripple effect has naturally hit jobless claims which have dipped to a 5-year low.

The seemingly relentless carousel of UK growth is again prompting the market to throw around estimates as to what this means for interest rates. Inevitably, interest rates will rise – “it’s not if, it’s very much when”

Carney stressed at the House of Lords yesterday that an increase will only be considered once the jobless rate scuttles below 7%. However, this guidance is underpinned with knockout clauses that mean a rate change will not ensue automatically once we hit 7% with wider economic factors also in play.

Data of note out of the UK today includes – Retail sales.

EUR

Minimal news for the market to digest yesterday. Fundamentally, the euro was on the sidelines for most of the day as the market waited for the evenings FED kickoff and QE announcement. Volumes picked up following the surprise result. London closed with the euro taking a minor hit against both the euro and dollar and sustaining minor losses.

The only data worth a mention was the overwhelmingly positive German IFO confidence survey, which came in at a 20-year high. This will please euro investors who look to Germany as the zones strongest economy to lead by example. The German economy is clearly in a festive mood and it looks unlikely that the party will stop next year with sentiment widely bullish towards the German economy breaking strongly out of the traps next year. Following the recession, Germany quickly recovered and Growth catapulted. We then saw a minor retracement as it returned to more sustainable levels. It is now set to peak up again next year.

Elsewhere, ECB political developments are drawing to a close and will have huge implications for the future banking foundations of the eurozone. Presently, EU leaders are edging closer to an agreement to empower the ECB to wind up failing banks. The ultimate aim is to have the capability to dodge the possibility of another catastrophic situation as seen during the recession – failing banks in struggling nations – Ireland, Greece etc., which brought their states to the brink of bankruptcy. Leaders are desperate to ensure this does not happen again, hence the shift in legislative banking powers for the central banks.

Data of note out of the EU today includes – EU current accounts.

USD

Following the taper the immediate response was a slight USD dip and fall in US stocks. However, this was quickly reversed and hot money poured into the market. The USD proceeded to climb against most pairs and over the Asian session hit a significant 5-year high against the Yen. The greenback failed to close up against the pound. However, there were some gains against the euro. US stocks also saw gains and volumes were heavy over the Asian session.

The FED pantomime was sold out yesterday. The theatrical state of the FED leading worldwide markets came to a crescendo with the surprise taper catching many off guard. Fundamentally, this initial taper is really just a minor tweak in the mechanics of the mammoth FED QE. Starting January, the FED will scale back $10mln evenly from both the monthly buy back of mortgage backed securities and US T-bills. Also confirmed is a widely expected revision in the rate of unemployment prior to a significant pullback in QE. The revised unemployment figure the FED is aiming for is now 6.5%

Market muscles have been flexing to the steroids of QE for the past 15 months. The FED now feel the economy and wider market is strong enough to begin a minor reduction in the dose of QE. This view has stemmed from the rapid drop in unemployment and growth of the US economy. Overall, this move is a toe in the tapering water, the absolute minimum reduction the Fed could announce without looking timid. The point here is that “consistent progress” towards full employment is cited as the key driver of the decision. Therefore, we now have to assume further tapering in Q1 unless payroll growth slows, or financial conditions worsen markedly.

The overall impression is one of greater confidence that the economy is gaining momentum, though the Fed is at pains to point out that any rise in rates is still a long way off, even if unemployment dips below the 6.5% threshold relatively soon. Given the unexpectedly rapid fall in unemployment over the past couple of years, this is a prudent attempt to prevent markets from pricing-in higher rates too soon for the Fed’s liking. Whether this enhanced guidance can keep a lid on the curve if the data strengthen is another matter altogether. Either way Q1 next year is going to be exciting.

Data of note out of the US today includes- Initial jobless claims, existing home sales and the Philly Fed manufacturing survey.

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Written by Tom Tong

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