Federal Reserve System: How Will FOMC Tapering QE & Emerging Market Turmoil Impact The US Dollar In 2014?

on January 29 2014 1:58 PM

U.S. stocks tumbled on Wednesday, with the Dow dropping as much as 174 points in early trading, as investors continued to weigh fears in emerging markets and await a decision from the Federal Reserve on whether the central bank will taper its stimulus program once again.

The Dow Jones industrial average fell 133.71 points or 0.84 percent, to 15,794.85. The S&P 500 lost 11.90 points or 0.66 percent, to 1,780.57. The Nasdaq Composite dropped 27.36 points or 0.67 percent, to 4,070.35.

The Federal Reserve’s two-day policy meeting concludes on Wednesday,  with the Federal Open Market Committee (FOMC) scheduled to release a statement at 2 p.m. Eastern. The meeting will mark the last for outgoing Fed Chairman Ben Bernanke, as current Vice Chair Janet Yellen prepares to take over on Friday.

“The Fed’s going to do what the Fed thinks they need to do. Everyone was expecting them to taper previously and they didn’t. They’re going to do it on their own time table,” said John Curran, Senior Vice President at USForex. “The market always looks at these things to sort of be a straight line effect. That’s not what the Fed is going to do, I don’t believe. Whether he’s [Bernanke] going to do another $10 billion now, I really don’t know. I didn’t expect them to do it last time, but it wouldn’t be a great surprise if they did. I think what would be more surprising would be if they didn’t.”

The FOMC announced plans in December to taper its $85 billion-a-month bond-buying program by $10 billion in January, surprising some investors. Market professionals now await the Fed’s announcement Wednesday afternoon to prepare for another possible cut to the central bank’s quantitative easing program.

“There’s two schools of thought, one being ‘They’re not tapering, lets sell U.S. and wait for more numbers,’ while the second is ‘They didn’t taper now, they’re going to taper next time so let’s just keep on buying U.S. dollars.’ It’s not a simple buy or sell U.S. dollar scenario,” said Curran. “The caveat to this is we’ve now got the EM outflows affecting US. dollar strength as well. So that’s a bit of a wildcard in this. If I were a betting man, I would think that if they didn’t taper that you would see some dollar weakness.”

Although U.S. stock futures rallied early Wednesday on news the Turkish central bank raised its overnight lending rate to 12 percent from 7.75 percent, the lira fell despite the rate hike, sending Wall Street tumbling in morning trading on emerging market concerns and weaker-than-expected corporate earnings from Yahoo! Inc. (NASDAQ: YHOO), AT&T Inc. (NYSE: T) and The Boeing Co. (NYSE:BA).  The Turkish central bank also raised the overnight borrowing rate to 8 percent from 3.5 percent.

“So emerging markets and other growth currencies are taking the brunt of this hit as the effects of tapering are being realized. So people are pulling their money out of those,” said Curran.

Emerging-market currencies got slammed last Friday due to political turmoil in countries such as Turkey and Argentina, sending the Turkish lira to a new record low against the dollar, while the Argentine peso dropped nearly 20 percent.

“We’re just seeing a continuation of what is going to occur as quantitative easing is scaled back and tapering occurs,” Curran said. “Whether or not the market has gotten ahead of its self, maybe it has with the EM and some of the ‘risk currencies.’ They may have gotten a little ahead of themselves. There seems to have been a dramatic push recently on the EM side enough to get those central banks propping up their rates.”

Although the Fed announced last month it would scale back its asset-purchasing program by $10 billion to $75 billion-a-month in January, Bernanke reiterated the central bank would maintain record low interest rates near zero during 2014.

“When the Fed crystalized it for the markets and separated interest rates from tapering, that helped a great deal to help get people’s mind wrapped around the Fed’s methodology,” said Curran. “Low interest rates don’t appear to be dramatically hurting the dollar, and tapering is the name of the game right now. People are prepared for interest rates to remain low for quite some time.”

Ahead of the Fed’s highly-anticipated announcement on Wednesday, the dollar initially rose against the yen and Swiss franc, but then weakened on the Turkish lira and emerging market fears as analysts forecast the FOMC will taper its stimulus program by another $10 billion to $65 billion in February.

“As far as the dollar’s performance in 2014, it’s been pretty good so far,” Curran said. “We’re hitting levels in the dollar that many people were looking for as mid-year targets or highs for the year in some cases. Is there a great deal of more dollar strength in store? I would tend to think maybe against sterling and euro you could see some dollar strength, and the dollar yen.”

The dollar edged down 0.26 percent against the Swiss franc at 0.8949 franc, while the dollar index fell 0.04 percent to 80.5330 after two days of gains.

“As far as Yellen’s impact, usually when you have a change of the head of an institution like the Fed they usually don’t try to do too many things outside the box straight off the bat,” added Curran. “I think that will definitely be the case with Yellen. She’s not going to come out with any dramatic changes. She may put her stamp on the office in subsequent meetings, but I don’t think we should expect any great changes out of her initially.”

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