• Overview

    The US Federal Reserve began the discussion of reducing the amount of monthly bond purchases this month. The move should not have been a surprise given the strength in the economic indicators of late.

    Post the announcement from the Federal Reserve, cyclicals began to sell-off in favour of defensives.

    Some of these stocks are also under pressure as the stronger dollar weighs on commodities, even as declining yields help bond proxies such as utilities.

    An equal-weight gauge of cyclical versus defensive sectors has now fallen to the lowest since February. Materials are by far the worst S&P 500 performer in the past month.

    Chart 8: Cyclicals may have peaked with US manufacturing activity

    Source: Bloomberg

     

    Despite the stronger employment report in Australia, downward pressure remains on the Australian dollar driven by the stronger USD.

    Tapering of bond purchases by the US Federal Reserve takes a big weight off the shoulders of the greenback.

    The resulting downward pressure on the Aussie dollar bodes ill for Asian equities if past relationships hold.

    This would be consistent with a weakening in commodity prices associated with a weakening of activity in emerging markets.

    Chart 9: Follow the Aussie – a weaker AUD coincides with weaker Asian equities

    Source: Bloomberg

     

    While US financial conditions still remain at levels that are very accommodative, it is the change in conditions that matters most for financial markets.

    The change in tone from the US Federal Reserve this month, indicating it is considering reducing the amount of bond purchases each month, represents a move towards less accommodative financial conditions.

    Not surprisingly, US equities reacted negatively to the news having been sustained on a diet of cheap, easy credit for so long.

    Chart 10: Taper talk tightens financial conditions and weighs on equities

    Source: Bloomberg

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