Market QE tapering: the law of the unintended consequences

Posted: January 28, 2014 in Uncategorized
Tags: , ,

I always warned to pay attention to the markets: all these new market strategies (Eg Quantitative Easing) invented and introduced by the Central Banks and Government really saved us from financial destruction in 2008. But they also introduced potential black swan events that in many case can be “potentially seen”, but that can never be forecasted. A bit like land mines. You know they are there….but you will never know if or when you hit them

For example last year in Japan for 2 days the Japanese bond market went haywire until the Bank of Japan intervened.

And there are quite a few other risks, as these few days showed. What happened?

In  two days the SP500 fell almost 3% going to oversold and now sitting on the last defence (DSMA 75 days – at the break of that it would aim for the SMA 200 – 1710). We have been somewhat sheltered by the Australia Day holiday.

On news/media analysis all was sparked by the PMI reading in China. This acted as a contagion fear as Emerging Markets are on a verge of a high inflation/ debt default (specially we find that Brazil, Argentina, Thailand, Indonesia,Turkey, Ukraine are under stress).

Delving on the matter this is one of the unintended consequences of the tapering of the US Federal Reserve stimulus (the Fed is holding a 2 days meeting now):

– The Federal Reserve Quantitative Easing flooded the emerging market with easy money that fuelled growth, but also growth. Now that capital repatriates to the US.

-Emerging Markets Government, in the face of slowing Western consumer demand, did their own style of quantitative easing increasing the debt size.

– China is restructuring – Bank of China always use the Chinese Spring Festival period. In this case the POBC used buy-back purchase of 21 days reverse REPOs to restrict liquidity during the Spring Festival (which automatically will unwind in 21 days). Liquidity issues and credit liberalisation will be the focus of  2014.

Investment scenario:

Thursday was the start of the crash. There was some unidentified (FED probably) support at the end of the day that limited the damage.

Friday the support was taken off and even market intervention did not save the day.

Monday was a day of stabilisation and ended off the lows – a few minutes from the final bell it still ended in slight negative territoriy – but it wasn’t a crash.

The market does not look in panic mode, but the big decider will be the big corporate earning situation in the US (Apple , Amazon and Google ) and outcome of FED. We are tethering on the edge.

I think this is a warning shot of things to come. We are not in crash status and this healthy correction could also make the Fed (currently in meeting) rethink its bond purchase program. So in the end , the rally could resume into March.

But a warning shot is a warning shot. Usually another, harder, will follow when you do not expect it

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