Talking Points

Yen Rallies, Aussie and Kiwi Sink as Risk Aversion Engulfs Asian Markets
Seesawing Sentiment Trends Reflect Uncertainty Ahead of FOMC Meeting
Dollar May Turn Lower Anew as Soft US Data Informs QE ”Taper” Bets

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Risk appetite unraveled overnight, weighing on the sentiment-linked Australian and New Zealand Dollars while driving the Japanese Yen higher on the back of safe-haven demand. The MSCI Asia Pacific regional benchmark stock index fell 0.5 percent. The newswires chalked up the move disappointment about China’s ability to reign in borrowing costs, a recently prominent sore spot. The PBOC injected CNY13 billion into the market after a two-week pause in liquidity provision but the benchmark 7-day SHIBOR rate still advanced to a new there-month high of 4.497 percent.

We see the move in a larger context, reflecting seesawing sentiment trends ahead of Wednesday’s much-anticipated FOMC policy announcement. A “risk-on” mood was prevalent yesterday but investors are reasonably unwilling to commit to a sustained directional bias before getting an update on the Fed’s timeline to begin scaling back its QE3 stimulus program. With that in mind, today’s “risk-off” lean appears to be a function of profit-taking, returning market-wide sentiment to a broadly neutral setting.

The consensus view on the timing of the first cutback in asset purchasesbegan to shift in response to October’s US government shutdown, with the baseline scenario now pointing to March 2014 as the start of the normalization process. The incorporation of this view into asset prices over recent weeks has pushed the S&P 500 to a new record high and sent the US Dollar sharply lower. The commencement of this process increasingly suggests any outsized volatility is likely to come from an indication that QE “tapering” will begin sooner rather later.

Recalling the ultimately unfounded fears of the fiscal drag from an increase in payroll tax withholding and the “sequester” spending cuts on the US recovery earlier this year, the possibility that worries about the shutdown’s impact are overstated seems quite real. Furthermore, given the Fed’s recently spotty record of managing investors’ expectations, officials will probably want to see more hard evidence on the shutdown’s impact before tinkering with existing guidance. That means the absence of a discernible dovish shift in the FOMC policy statement’s rhetoric may significantly weigh on risky assets and boost the greenback.

In the meantime, a quiet European economic calendar is likely to see markets looking ahead to US Retail Sales and Consumer Confidence data. Draw-downs are expected on both fronts, which may help boost risk appetite in the near term. S&P 500 futures are trading flat in late Asian hours, hinting the door is open for a pro-risk shift in prevailing trends.

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