We need a new normal

Yesterday was an important day, the first signal from the US FED that they are willing to reduce and if possible remove altogether stimulus for the economy. There has been much said about tapering back of purchases of bonds over the last month but confirmed yesterday by Bernanke that hopefully the new normal will be reducing QE as the economy learns to walk again until time that it is running and they can exit altogether

As it stands the US is purchasing bonds worth approx $85bln a month the aim is to reduce that down as the economy and in particular unemployment is improving with the aim of 7% unemployment a threshold level to break before the FED considers taking such actions.

I think Bernanke has found the sweet spot here as much has been said over the last month or so regarding tapering but most of it unfounded conjecture and opinion which was causing a large degree of volatility in markets around the world. 

In essence he has said we are still here for you, if the economy improves then we have a process in place to begin withdrawing the methadone from the patient. The FED has sent a clear message with no ambiguity now to try and direct investors attention to focusing on what really counts which is the economy not consistently focussing on how much or how often the FED are making purchases. 

This was attempted a month or so ago and served to increase volatility not reduce it. I feel this was also on purpose as another role of central banks is to reduce systemic risks in the market and there is a very real risk even still of a bond bubble. Bonds have been sliding since tapering was first mentioned which is no bad thing unless you bought the top of course but long term government bonds were getting to relatively dangerously low yields. After the European debacle this must be confusing as most are thought to be worried about high yields on govt bonds- that is an problem for the issuer, a low yield on a government bond is a problem for the buyer of that bond. Also at the time equities were starting to look pretty frothy and that usually also correlates well with increased leverage being built up in the system. Personally I think the FED gave the tree a shake a month or so ago in the first warning shot to investors to cool down and reprice expectations. Those who took the hint a month or so ago have done well, those who didn’t are busy repricing now.

The ” normal” for the last few years for markets and investors have been to hang on every word said by central bankers, and while this will still take a while to shift I think we are at the beginning of finding a new normal, one that may look historic before the global financial crisis but also one that focuses more on the actual economy rather than every word or nuance to leave a central bankers mouth. 

Interest rate expectations need to be repriced, bonds need to be repriced across the curve i.e short dated and long dated, equities need to be repriced especially those offering a low or high dividend yield and as always FX needs to reprice to reflect the probability of a stronger dollar in the future. Carry trades will unwind further although some real damage has already been done to them look at the Aussie dollar for evidence.




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