With less than 4 hours to go with in September, the next quarter looks set to start with a lot of uncertainty and volatility. The Government has yet to take action to stop the shutdown and the markets could see the week turn for the worst in coming days, but what is worst? For some asset classes it is tough to tall, the dollar, usually a safe haven may or may not remain one, in my opinion I think that there could be a shorter term rallying in the dollar as investors dump risky assets (high yield bonds, emerging markets, and equities) and park money into dollars. This trend could shift, and quickly if the shutdown looks likely to last more than the week, and other havens, such as the Yen and Pound could see a significant rise, this could lead to opportunities, but in the near term the only real rallies for the global market, in the absence of a deal, seem likely to be bonds and cash.
The Japanese Yen has been rallying after the Fed decided not to taper. The stock markets in the US are also in decline after the remarks from the Fed meeting are being digested (fed governors speaking on circuits doesn't hurt either). The interesting part of this scenario is the lack of increase in the Dollar, specifically to the Yen. In times of trouble, the Yen may still be proven as a safe haven and rally further to the Dollar and other asset classes (notably emerging markets). This could provide an opportunity to build short en positions to a variety of other currencies and short the Japanese indices as well.
A step back to look into this theory is that the Japanese government will have to take measures to increase tax revenues, potentially slowing the economy, or face a potential distrust in the ability to manage their debts. Overall t is my view that Japan will struggle to retain a strong commitment to Abenomic policies and manage the interest rates and economic growth of the country. While this is a long term play it is good to pay attention to the region over time and build into longer term, positive carry positions in the long run, and shorts to markets on shorter term scares (which could hedge and remnants of a move to Yen in a flight to safety during budget talks).
The fed has thrown a curve ball to the expectations that the market had. This led to a sharp reversal in the moves that have been taking place over the past month: Dollar dropped, emerging markets went up, and commodities (including gold) went up. This put a lot of the future market movements in the air, and continues to put emphasis on data that will come out of the US and other countries. This could see a gap emerge between the markets increasing on the news that QE is going to last longer than originally thought and the true causes for the lack of tapering; that the Fed thinks the economy does not have enough strength to grow without help.
With Fed talk upon us, many start to look for guidance in the news about what all this will mean for the markets, economy, and rest of the world. While much of it depends on actions in the future we can take the present facts and create a theory into the medium and longer term.
Currently the Fed is seen a completing some degree of tapering this meeting (10 to 15bln) and should be looking to stop all stimulus by the middle of 2014. This is the consensus of many so the movements in the markets will no doubt come from a deviation from these estimates or the tone of the language at the press conference.
In the medium term if the news is truly aggressive and the economy keeps pace with the Feds expectations for the full tapering in 2014, many other countries that are not welcoming higher rates (the ECB ad BOE) will have to find a way to differentiate themselves from the interest rates of the US, which will no doubt continue to rise.
Longer term if the Emerging Markets do not pull their economies out of their addiction to FDI much of this excess money (remember that tapering is slowing the increase in money supply not removing any) will come back into the US for investment which will import inflation as many of the central banks will need to sell dollars to stabilize their currencies. This could bring about more inflation in the US which will support the increase in rates as well as gold.
This creates a need for a true decoupling to occur, not in growth but in interest rates. A strengthening US economy and rising yields should not be inherited by other countries that are not ready for it.
The opening of the markets has seen a drop in the dollar across the board as of the Fed Reserve Chairman candidates, Larry Summers, has dropped out of the running. Seen as more of a critic of the current stimulus plan, Summers drop out of the race has market participants re-evaluating their bets on the future of monetary policy under potentially Janet Yellen. I think the moves in the markets will be volatile going into the Fed meeting but this should not be looked at as a function of Summers dropping out of the race. A lot can happen over the course of the next 4 months and the fed will be able to start a tapering program that is unlikely to change too drastically into next year. It is important to note that the news of tapering is exactly that, a slowing down of stimulus, not a reversal. The plug is still in the liquidity sink drain, the Fed is just slowing down the pace of the faucet.