Time of writing: 03:30 GMT

The big picture

Start of tapering = start of USD rally of 2014 The FOMC decided to begin tapering off its bond purchases at yesterday’s meeting, as we had expected. The Committee cut both its Treasury and mortgage-backed securities purchases by $5bn each, bringing its monthly purchases down to $75bn. They didn’t commit to a specific pace of tapering; Chairman Bernanke intimated that the Committee is likely to reduce purchases by a similar amount at each meeting, which would mean ending its purchases “late in the year, not certainly by the middle of the year,” but he stressed that the pace of tapering is not fixed but rather will depend on the course of the economy. If they do cut by the same amount at every meeting, then QE will end at the October meeting.

Markets were extremely volatile following the meeting, but at the end of the day the impact on the Treasury market was muted, with 10-year yields rising only 6 bps on the day (and most of that before the announcement), suggesting that the move was well discounted in that market. The implied rates on the 2016 Fed Funds futures on the other hand fell by 1 to 2.5 bps due to the inclusion of a new sentence in the statement that said “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2%, especially if projected inflation continues to run below the Committee’s 2% longer-run goal.” In other words, the Fed balanced the tapering off of its bond purchases by extending its forward guidance and making it conditional on inflation expectations. Fed funds expectations are now below where they were before all the tapering talk began back in May, at least out to end-2015. This demonstrates the success of the Fed’s forward guidance in keeping rate expectations separate from tapering expectations. From now, investors will be watching the strength of the economy, particularly the labor market, to gauge if the Fed is likely to bring forward the time when it begins to tighten. This is exactly what’s been happening with Britain and the Bank of England’s forward guidance, and I would expect to see a similar result with the US and USD: as the US economy continues to improve (I assume), the market will adjust its estimate of the timing of the Fed’s move and the dollar will rally, much like the pound is currently rallying as unemployment there falls more rapidly than expected and rate expectations shift (see below).

The dollar soared against most currencies, with the largest gains over the last 24 hours against CHF (1.2%), CAD and JPY (1.0%), and EUR (0.8%). It was lower only against GBP, as a result of yesterday’s announcement of a surprisingly large fall in unemployment in October. The dollar also gained vs most EM currencies, particularly INR, KRW and HUF.

So where to from here? The response to the tapering was violent: USD first rose, then fell, then rallied back again after EUR/USD was unable to break through 1.3800 yet again. I think we may have reached a turning point for the dollar. I’m especially intrigued at the weakness in CHF. CHF was the biggest loser during yesterday’s European morning trading, which was rather difficult to explain as the Credit Suisse ZEW survey rose to 39.4 in December from 31.6. Then it was similarly the biggest loser overnight following the FOMC meeting. The rise in USD/CHF along with USD/JPY suggests to me that carry trade funding is moving decisively out of USD and into other currencies. Plus the last vestiges of the anti-inflation hedges are being dismantled (gold was also down 1% while silver fell 1.8%). I think this marks the start of the USD rally that many commentators have been predicting for 2014.

Today the UK retail sales for November, excluding autos, are expected to be up 0.3% mom, a turnaround from -0.6% in October. That would signal a continuation of the consumption-led expansion in Britain and probably add further fuel to the GBP rally. In the US, initial jobless claims for the latest week are expected to fall to 335k from 368k, which would bring the four-week moving average to 335k, in line with the previous 331k. The December Philadelphia Fed survey is expected to improve to 10.0 from 6.5, which would add to the bullish USD sentiment. Existing home sales for November are seen falling slightly to a 5.02mn annual pace vs 5.12mn in October, but that is probably not enough to disrupt expectations of continued tapering.

The Market

EUR/USD

• EUR/USD plunged after the FOMC decided to dial back its monthly bond purchases by USD 10bn. The pair violated the 1.3710 barrier but the fall was halted by the 1.3655 (S1) support, which coincides with the lower boundary of the upward sloping channel. A clear dip below that hurdle may trigger further declines towards the next support at 1.3600 (S2). The MACD oscillator got a negative sign, confirming the bearish momentum of the price action. However, the uptrend remains in effect from a technical point of view since the rate is touching the trend line and a rebound may signal the continuation of the upward path.

• Support: 1.3655 (S1), 1.3600 (S2), 1.3530 (S3).

• Resistance: 1.3710 (R1), 1.3800 (R2), 1.3830 (R3).

EUR/JPY

• EUR/JPY moved higher, but gave back part of its gains after hitting the resistance of 142.80 (R1). The rate remains between the support of 140.88 (S1) and the aforementioned resistance level. A clear break from either direction would signal the short-term path of the pair. I remain neutral on EUR/JPY at the moment, since our technical studies provide mixed signals. The 50-period moving average provides reliable support to the price action, but negative divergence is identified between both momentum studies and the price action, indicating that the trend’s momentum is decelerating.

• Support: 140.88 (S1), 139.67 (S2), 138.00 (S3).

• Resistance: 142.80 (R1), 146.85 (R2), 148.75 (R3).

GBP/USD

• GBP/USD surged yesterday after the larger-than-expected fall in the UK unemployment rate. The pair rebounded from the support area between the 38.2% Fibonacci retracement level and the 1.6260 (S2) key barrier and jumped, breaking above the hurdle of 1.6347. The MACD entered its positive territory, crossing above the downward sloping resistance line, confirming the recent positive momentum. A break above the 1.6464 (R2) ceiling should drive the price in territories last seen back in August 2011 and could have larger bullish implications.

• Support: 1.6347 (S1), 1.6260 (S2), 1.6140 (S3).

• Resistance: 1.6415 (R1), 1.6464(R2), 1.6570 (R3).

Gold

• Gold fell sharply on the FOMC decision, breaking below the 1224 barrier. In early European trading the precious metal is trading between that level and the floor of 1210. A clear violation of the low at 1210 (S1) might confirm that the 4th-10th Dec advance was just a correction at the 38.2% Fibonacci retracement level of the prevailing downtrend and could turn the bias to the downside again.

• Support: 1210 (S1), 1180 (S2), 1155 (S3).

• Resistance: 1224 (R1), 1251 (R2), 1267 (R3).

Oil

• WTI continued consolidating above the 97.00 (S1) support barrier. If the bulls manage to gain momentum in the near future, I would expect them to drive the battle higher and challenge once again the resistance of 98.81 (R1). Nonetheless, both momentum studies lie near their neutral levels, giving no clues for the next directional movement of the price. As long as the 50-period moving average remains above the 200-period moving average and as long as WTI remains within the purple upward sloping channel, I consider the bias to the upside.

• Support: 97.00 (S1), 95.36 (S2), 92.00 (S3).

• Resistance: 98.81 (R1), 101.10 (R2), 103.15 (R3).

BENCHMARK CURRENCY RATES – DAILY GAINERS AND LOSERS

MARKETS SUMMARY