Surprise Taper Delay Spurs Equity & Bond Rally

The US Federal Reserve (Fed) decided to maintain its US$85bn asset purchasing programme on September 19, a more dovish move than we had expected. Financial markets were similarly caught off guard, and US equities and fixed income rallied, while the dollar weakened , on news that the current round of quantitative easing (QE3) will continue unchanged. We had previously identified the possibility that the recent deterioration in US jobs data and consumer confidence could make result in a weakened - or even delayed - tapering of QE3 ( see 'More Moderate Taper Possible', September 13 ) .

Market Over-correcting?

The news that monetary stimulus would continue precipitated pronounced moves higher in US equities and fixed income, with the S&P 500 Index hitting a new high of 1,723 on what was a more dovish Fed decision than markets expected. Generic US government 10-year yields compressed over 19 basis points (bps) to 2. 67 %, breaking a strong level of resistance that had been in place since May, when the Fed raised the possibility of a September taper. W e had previously highlighted that a more dovish Fed move could see a rally in fixed income . Major currencies have also rallied against the dollar, pushing the dollar index 1.0% lower , with the dollar dropping against the euro from US$1.337/EUR to US$1.350 / EUR . However, it is only a matter of time before the Fed winds down QE3, and as such we believe there may be opportunity to take advantage of what will prove to be a temporary correction in markets. Specifically, we believe the rally in US debt will be short-lived, and that the dollar is likely to strengthen as monetary easing is wound down , especially against many emerging market currencies . That said, we believe there is more to support the current rally in equities from a fundamental perspective ( see 'Medium-Term Uptrend Confirmed', September 18 ).

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This article is tagged to:
Sector: Country Risk
Geography: United States

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