Taper delay set to light a fire under equities

US equity markets surged to new record highs last night as the Federal Reserve wrong footed the markets by deciding that the economic case for tapering simply wasn’t there.

This surprise move is likely to see Europe’s markets surge this morning with the Dax set to open at new record highs.

Some in the markets have argued that the Fed lost its nerve last night, but I would suggest these are the ones who were simply the wrong side of last night’s move, as US treasuries moved sharply higher, pushing yields sharply lower.

The case for tapering was always a flimsy one based on the economic data, and the clues were there for those prepared to look, not only in the data, but also in the US bond markets, which were looking as if they were about to turn around and push higher, as yields started to drop back from the 3% level.

It would appear that Bernanke has serious concerns about the possibility of the upcoming political deadlock in Congress over the debt ceiling, and a government shutdown, which may well have also played a part in the Fed’s decision to delay a decision on a taper, though a downgrade to the Fed’s growth forecasts for this year and next, could well have also played a part as well.

Even so the Fed’s communications strategy is once again likely to come under scrutiny especially after last night’s press conference where Bernanke didn’t rule out a taper later this year, but he also insisted that asset purchases were not on a preset course, which would appear to throw into doubt his deadline that asset purchases would cease by mid-2014.

It therefore looks like we are back in the goldilocks scenario of bad news is good news again, with the possibility that good news is good news as well, and the earliest we could see a taper is at the December meeting, data permitting.

While markets absorb the fallout from last night’s decision one central banker not laughing will be the ECB’s Mario Draghi because a rising euro increases the difficulties for the weaker European countries trying to re-orientate their economies back to growth, though we could well see a welcome fall in peripheral borrowing costs as a result.

In Italy the Berlusconi ouster story continues to be played out with a final decision expected sometime in October. While the risk of government collapse is always there it remains doubtful that Berlusconi would trigger such a move to bring down the government imminently, given that it would undoubtedly be his final card, and could end up backfiring on him in any new poll.

Back in the UK the pound has also risen sharply in the past few days as economic data continues to improve, while the Bank of England yesterday upgraded the UK’s growth forecast for Q3 to 0.7%, though concerns remain about the resilience of the recovery given the continued gap between average incomes and inflation.

We should find out today if that gap has had an effect on the August retail sales numbers after July’s blow out sunny weather related 1.1% number.

Did UK consumers still feel confident enough to continue spending as the kids got set for a return to school? Expectations are slightly more modest with a rise of 0.4% expected.

After last night’s shenanigans in the US we have the small matter of weekly jobless claims after last week’s 292k number, which is expected to be revised upwards, while this week’s number is expected to come in at 330k.

We also have the latest Philadelphia Fed survey for September and after this week’s Empire manufacturing disappointed to the downside it wouldn’t be a surprise if we saw a similar disappointment here. Expectations are for a rise to 10 from 9.3, while August existing home sales are expected to decline 2.6%.

EURUSD – yesterday’s break above the 1.3400 area opens up the possibility of a return to the high this year at 1.3710. Any pullbacks are likely to find support at around the 1.3420 area, and it would need a break below here to retarget the lows this week at 1.3320.

GBPUSD – the close above the 200 week MA at 1.5740 last week proved to be remarkably prescient as we blew through 1.6000 and have seen pushed beyond 1.6120. It looks increasingly likely that we could well see a retest of the highs this year at 1.6370. The area between 1.5980 and 1.6020 is now likely to act as significant support on any move back down. Only below 1.5980 suggests a move towards the lows this week at 1.5880 and the medium up trend support now comes in at 1.5680 from the 1.4815 lows.

EURGBP – Fridays break below the 0.8390 area now opens the prospect of a move towards the 0.8320 area and on the way to the 0.8280 level, 50% retracement of the 0.7755/0.8815 up move. As long we stay below the 0.8480/90 area and 200 day MA the outlook remains bearish.

USDJPY – the worry that the US dollar could roll over was well founded as the dollar dropped sharply through the support at 98.40 and we now look set to test the trend line support at 97.30 from the June lows at 93.85. Any rebounds could well see resistance come in at the 98.50 area, and we would need a move back through 99.30 to stabilise.

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