Although it was widely expected the Federal Reserve’s decision to implement a fresh version of Operation Twist together with a downbeat assessment of the economy came as a disappointment to equities and risk assets in general. The only surprise was the larger size of the operation at $400 billion.
Moody’s downgrade of three US banks added to the malaise as US equities dropped sharply, commodities slid, longer term Treasuries rallied whilst shorter term bonds dropped. The USD registered broad gains both on the back of the fact that no more quantitative easing was announced and due to a shift away from risk assets. At least there was no more negative news out of the eurozone as talks between the Troika (ECB, IMF, EC) and Greek officials continue on the next tranche of the bailout.
Markets will continue to digest the Fed’s outcome today and the negative tone will likely filter through markets today. There is little on the data front to result in a shift in this tone. In the US data includes weekly jobless claims while in Europe attention will be on manufacturing and service sector confidence measures.
While the potential for a positive outcome to talks in Greece may provide a short term boost to sentiment the overwhelming tone is likely to remain negative especially as Operation Twist is unlikely to change the dynamic of a weak growth trajectory for the US and developed economies over the coming months. Against this background, selling risk assets on rallies remains the preferred option.
The USD will continue to look firmest against high beta emerging market currencies in the current environment. Currencies in this group are those that have the highest correlations with risk (as m measured by my in house risk barometer) over the past 3 months including CAD, ZAR, TRY, INR, MXN, ARS & RUB. In contrast currencies that also have high correlations but actually strengthen as risk aversion increases are CNY and JPY.