Fed pulls the trigger

The guessing game is finally over as the US Federal Reserve took a major step away from the extremely easy policy conditions implemented since the financial crisis by tapering its asset purchases by USD 10 billion, split equally by reduced Treasury and mortgage backed securities purchases. Indeed the Fed finally put markets out of their misery but successfully massaged the market reaction.

The Fed is set to gradually reduce asset purchases over coming months, likely ending its QE program by late 2014. The decision was supported by most Fed officials but to soften the blow the Fed strengthened its forward guidance, helping equity markets to rally while encouraging the short end of the curve.

Conversely Treasuries came under pressure and yields rose, giving a boost to the USD. Markets are likely to digest the news well in the Asian session following the lead from US markets. Nonetheless, while the Fed decision was predicated on stronger growth, the decision will presage a competition for capital especially among emerging markets.

The biggest FX reaction unsurprisingly (given its greater sensitivity to US yields) came from USD/JPY, with the currency breezing past the 104 level. However, given that US yields have not pushed significantly higher in the wake of the Fed tapering decision the boost to the USD will be limited in the short term. Indeed, FX markets will likely digest the Fed news will little reaction both in major and emerging market currencies in the short term.

Further out, the prospects for contrasting policy stances between the Fed, ECB and BoJ imply that the USD will forge higher against the EUR and JPY as well as other major currencies. Meanwhile, highly correlated currencies with US Treasury yields, in particular in the emerging markets spectrum, including INR, TRY, and BRL, will be the most sensitive to an expected rise in US yields over the coming months.

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