Tags: Fed | gold | taper | recovery

Can Global Economic Recovery Withstand a Fed Taper?

Tuesday, 03 December 2013 12:28 PM Current | Bio | Archive

Last week, the European Central Bank, in its twice-yearly "Financial Stability Report," warned the whole spectrum of market participants not to underestimate the impact of a "coming" decision of the Federal Reserve to start tapering its asset-purchase program. This would definitively change the global as well as U.S. monetary policy expectations, whereby, most probably, interest yields should start moving higher from current levels.

We all know once the Fed starts tapering its bond-buying program its action could cause renewed tensions and probably won't be supportive for various categories of equity, bond and commodity prices.

All this wouldn't be a problem if we had a harmonized, synchronized global recovery, more specifically in the euro area, the emerging economies as a whole and even in China, which nevertheless remains in a world on its own.

In my opinion, we could see the weak points of the euro area sovereign debt complex resurfacing again. It's a fact that especially fiscal imbalances inside the eurozone, but also in other places over the globe, haven't been addressed as they should have been.

It remains an open question if the so-called global recovery that remains muted and uneven and where real and financial global imbalances remain high by historical standards will be resilient enough to face a logic U.S. "normalization" of its monetary accommodative policies.

Long-term investors shouldn't overlook the fact that global risk premiums have been compressed for an extended period of time, not because of organic growth, but mainly because of the huge monetary stimulus that was put in place by the Fed.

It must be noted that also, albeit to a lesser extent, different monetary easing schemes were put in place since the crisis started by the Bank of Japan, the European Central Bank and others.

Because of all these very accommodative finance policies, emerging economies have taken advantage for an extended period of time of strong capital inflows because the global search for yield. Now, once the Fed starts "tapering" that search for yield could disappear very quickly, which in turn probably should hurt the emerging economies to a large extend.

No doubt a global re-pricing of risk is fully in the cards and that by itself could cause capital outflows from these regions, which also include the weaker euro area economies like Spain (latest manufacturing Purchasing Manufacturer's Index still contracting at 48.6), Italy, Portugal, Greece (latest manufacturing PMI continues contracting at 49.2), but also and most importantly France, the second most important economy of the euro area. The Markit France Manufacturing PMI came in at the uncomfortably contraction indication of 48.4 (below 50 is contracting).

I'd like to add here there is a real risk we could see in 2014 a resurgence of the euro area sovereign debt crisis situation as an "unintended consequence" of the Fed starting tapering, which is in fact nothing more than a first step of a long way to "normalization" of its monetary policy.

Besides all that, on Monday we got two sets of positive U.S. data that indicated the growth trend continuous to expend.

First, the Market U.S. Manufacturing PMI came in at 54.7 (growth accelerating) for November, while the three-month average came in unchanged at 53.1, which signals continuous positive readings. Importantly, employment continued to show growth at 52.3 in November, albeit slightly down from 52.7 in October.

Second, the Institute for Supply Management (ISM) Manufacturing report for November came in at 57.3 (the highest since March 2011), up from 56.4 in October and growing for the sixth month in a row. Also, here we saw employment coming in at 56.6 in November, up from 53.2 in October and growing for five months in a row.

As a long-term investor and depending where your investments are located, one should not take lightly the fact that once the Fed starts tapering its bond-buying program it could have "out of the normal range" positive as well as negative impacts.

Please keep in mind at the end of 1993, the U.S. economic recovery was gaining strength and that triggered a rather abrupt tightening of the Fed's monetary policy that caused a spike in volatility and significant price corrections in local as well as global bond markets.

Of course, today we have what's called the Fed's forward guidance, so when tapering finally comes we should know it in advance. Supposing that's the case, I'm still wondering if that will be of great help to guide changing expectations regarding the U.S. monetary policy stance on a global scale.

Anyway, no long-term investor could err being prepared for higher yields coming in 2014. Yes, the "Alice in Wonderland" period of money for nothing could be coming to an end much earlier than many expect.

Finally, talking about gold for a moment, I think we are closing in on important price levels that could be starting points to significantly higher or lower prices. Today, gold bullishness is at very low levels and the market is surely oversold, which could cause prices to rebound. However, if on Friday we get a strong non-farm payrolls number, prices could easily fall through the year's low of $1,180 and lead the way to much lower prices. In this context, it is interesting to take notice that Societe Generale just lowered to $1,050 per ounce its expectations for the price of gold during the fourth quarter of 2014.

It's also an undeniable fact that today's gold prices are well below the publicly known global gold production cost price that stood at $1,221 (excluding write-downs and taxes) at the end of second quarter of 2013, as calculated by Hebba Alternative Investments.

Long-term investors should also never forget that markets overreact on the upside as well to the downside, and in the investment universe bottoms don't end with something like four-year lows, but they normally end with 10- to 15-year lows.

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Last week, the European Central Bank, in its twice-yearly "Financial Stability Report," warned the whole spectrum of market participants not to underestimate the impact of a "coming" decision of the Federal Reserve to start tapering its asset-purchase program.
Tuesday, 03 December 2013 12:28 PM
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