The Federal Reserve is trimming its monthly bond purchases to $75b from $85b. Previously there was fear of such tapering but now, markets cheer this move. This may be for reasons like 1) Less easing means that the value of the USD is preserved, 2) Uncertainty with regards to this issue is lifted, 3) Sell in anticipation, and buy on news. Let me explain point 1 since it is more technical and the rest are self-explanatory.
In past few days, flow data shows 1) a reversal to inflow into USD, 2) inflow into US Bonds, 3) outflow on US stocks. This may be in anticipation of tapering. Tapering means less money supply so USD will be stronger. Bonds have corrected a bit during the Stock market rally so to preserve the value of the USD, bonds make a better investment than stocks for now.
Why selling of US stocks and now US stocks jump after the tapering news? The reason here can be that US stock outflow was due to non-US investors as I have highlighted before. So, when the value of USD is now better preserved (less downside), non-US investors reload their US stock holdings in the short term.
What does it mean for traders and investors like us?
Further rally may be in the making. The Fed said its benchmark interest rate is likely to stay low “well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below” the Fed’s 2% goal. This means that hot money will continue to support the market and sentiment is positive for now. Any negative sentiment shall provide a healthy dip and opportunity for others to buy. The positive sentiment from the US is likely to affect developed markets (Europe, Japan, HK, SG) more. “2 weeks – 2 month – timeframe” positions on index component stocks may be optimal as we hold through to Yellen’s stepping into office.
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