Monday, 23 September 2013

Now is not the time to worry about the Fed's exit strategy

The Fed’s decision not to taper asset purchases on Wednesday has clearly left the market with a more bullish disposition than it had going into the announcement. I think it’s important to remember that 1) the impact of QE is more psychological than anything else; and 2) $10bio per month is pocket change in the scheme of things. So I expect the exuberance of the decision to not taper to be ephemeral.  Likewise when the Fed does eventually begin to taper (late this year or early in 2014) the angst will likely prove temporary as well.

Still, DM equities caught a bid and EM equities ripped higher! The USD suffered its worst slump in 3 months (consider than FX markets turnover nearly $5 trillion per DAY, in the context of an expected reduction in asset purchases of $10 billion a month if you still doubt the effects were are talking about here are predominantly psychological!) This lent considerable support to gold, the commodity complex and EM and commodity currencies.


10yr UST yields dropped expectedly and are now challenging near term support. I expect bonds will rally/yields will fall further from here…2.50% on the 10yr looks like a reasonable near term target.


The Fed has received a barrage of criticism in the press over poor communications and lost credibility (here, here, here, here) which highlights more than anything how much people hate to be wrong. I remain surprised by just how convinced the market was that we would see a September taper, given anything the Fed had told us.

Bernanke specifically mentioned “Upcoming fiscal debates may involve additional risks to financial markets and to the broader economy”. So even though markets are more psychologically predisposed to take risk as a result of the no taper decision, markets will not move up in a straight line if “Debt Ceiling Fiasco Mk III” looks like a high probability.

Changing the subject, I want to share with you below some charts that lead me to conclude that economic surprises over the next year or so could well be on the upside rather than the downside.

The chart below is of the Baltic Dry Index, one of the more common benchmarks of shipping activity. The index measures a combination of different shipping prices and gives a benchmark of the cost of freighting dry goods (e.g. coal, grain, iron ore) by sea. It’s a popular benchmark because the theory goes, when economic activity picks up, more goods get shipped and shipping rates rise.

Right now this index is having its best run in two years. It is coming off very depressed levels so I would hardly get too excited about the absolute level of the index. However it is moving decisively in the right direction - which serves as evidence that that things globally might be getting better.


Coincident with the rise in the Baltic Dry Index we can see that volumes at some of the busiest ports in the world (Shanghai, Singapore, Hamburg, Los Angeles) are trending up nicely:

Shanghai container volumes:

Singapore container volumes:

Port of Hamburg container volumes:

Los Angeles container volumes: 


Further confirmation of the current state of shipping can be seen in the stock price of the Guggenheim Shipping ETF, which is clearing 2-year highs:


There chorus of negative commentary fretting over the Fed’s exit strategy is significant. And look, one day the Fed will raise rates. One day the bull market in equities will be over. 

However what the charts above tell me is that a recovering world economy is the right trade to focus on right now. Now is not the time to be allocating investment capital based on worries over the Fed’s exit strategy. Let’s maybe start to worry about that in another year or so.