Taper Tease Reveals A Cautious Fed

Investment Quarterly — Fall 2013

We view the decision by the U.S. Federal Reserve to delay tapering as a cautious move by Chairman Ben Bernanke and the Federal Open Market Committee (FOMC), as we believe the economic recovery remains on track.

While recent employment reports have been on the weaker side, several other indicators have shown meaningful signs of improvement. Ultimately, it appears that Bernanke decided to err on the side of caution based on the FOMC's view that interest rates have been moving higher too quickly, inflation is running sufficiently below the Fed's target and contentious budget and debt ceiling negotiations are likely to impact investor and business confidence. In our view, the September FOMC announcement only delays the inevitable, and economic statistics over the near term could give the Fed the confidence it needs to move away from its extremely accommodative stance.

Merkel Win Promotes Euro

German Chancellor Angela Merkel was a clear winner in Germany's September elections—a largely positive outcome for markets. The elections solidified Merkel's pro-euro stance and demonstrated that Germans are comfortable with the country's assistance to peripheral nations in order to keep the union intact. While the European sovereign debt crisis has largely quieted in comparison to previous years, further progress is needed for it to become a more cohesive bloc —particularly in areas such as a euro banking union. The strong German coalition will be well prepared to deal with Greece, Portugal and Italy, which are not yet out of the woods. Overall, the German elections are supportive of European equities, and we believe a Merkel-led Germany will continue to make progress on achieving a more stable eurozone in the years ahead.

Commodities Check-Up

Until the taper talk eases, volatility is likely to remain elevated within risk asset classes. When investors return to a focus on fundamentals, return streams could become less volatile and diversified. Within commodities, the Energy sector may have limited upside as the premium brought on by the Syria situation is ameliorated by a production pick-up in Libya. Meanwhile, Precious Metals have suffered this year on expectations of an interest rate increase. However, if inflation approaches the Fed's 2% target and we experience a drop in U.S. unemployment, the sector could experience a bounce. A rebound in Europe and its auto industry could benefit platinum. Finally, any pick-up in Chinese demand could benefit Industrial Metals, with a delayed benefit from easy credit there potentially in the works.

Currency Focus

Recently, currency prices have been disproportionately influenced by changes in expectations on unconventional monetary policy action. Despite the "guidance" out of global central banks, actions have been unpredictable and continue to cause rapid swings in market positioning. Fundamentals, meanwhile, are gradually improving globally and price movements could normalize. In the U.S., despite positive economic activity, the dollar appears undervalued based on long-term metrics. In Europe, meanwhile, economic data has improved, but from low levels, and there is evidence of investors unwinding overweight exposures in euro- denominated assets. As a result, the euro has performed better than expected but growth remains modest. An increase in bank lending may help, but look for the European Central Bank to make efforts to keep both the yield curve and currency down in the near term.

This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation or solicitation to buy, sell or hold a security. Please see the disclosures at the end of the publication, which are an important part of this article.