Adjustment underway as Fed mulls exit of QE programme

While the FOMC had been telegraphing its reading on what it would take to stop the QE in the past, this last FOMC meeting provided a more specific timeline and frame of mind on what the FOMC is thinking about the health of the economy.

Specifically, the FOMC is quite bullish on the pace of the recovery of the US economy. For 2014, it forecasts growth at 3.25 per cent and unemployment at 6.65 per cent. This is a bit more bullish than the IMF’s 2.70 per cent and World Bank’s 2.80 per cent, while the IMF still sees the US unemployment rate in 2014 at 7.20 per cent. The importance of the difference in forecasts is that the FOMC timeline is quite data dependent, so future economic data will dictate the volatility of financial markets. 

However, if it’s necessary to predict the Fed’s action from the FOMC statement, the Fed will likely reduce the size of its monthly purchases in Q4 of this year. Then in 2014, the Fed will stop QE purchasing completely. Looking forward, the market has begun the unleveraging of investment assets. 

While it is difficult to forecast how long and how far these assets price will fall, it’s safe to assume that we are about to enter a new period of readjustment. The level of adjustment that we are already seeing may be just a test run of the kind of volatility we will see going forward. When the real deleveraging comes, what we have seen this past month will just be a small ripple compared to the actual tsunami. 

The baht weakened along with regional currencies this past month while the 10-year baht bond yield rose – or price dropped – by almost 70bps. This parallels what has been going on globally as the local market is expecting money to be pulled out of fixed-income and equity investment. However, we have not yet seen large-scale selling of foreign investors in either of those markets. The selling interest has been orderly. 

Where the baht goes from here will depend on whether there will be panic selling by offshore investors in the bond market. Non-resident holdings in baht bonds are about Bt800 billion. When those offshore investors entered the local market, they gradually entered from 2010-13. 

However if they were to leave all at once, market liquidity will have the depth to absorb the pull-out and it could get ugly for the bond yield and baht exchange rate. However, we are not at that stage yet. 

As the Fed timeline is very much data dependent, it’s still not written in stone. But do brace yourself for volatility going forward and take care of foreign exchange hedging. 

 

_ Thiti Tantikulanan is executive chairman of Kasikorn Securities