Negative Feedback Loop Predicted on the US Dollar

By Chris Godding, Head of Global Equity at Signia Wealth

It is ironic that the tapering of QE has a negative feedback loop on the US dollar.  Emerging Market currencies have been a major beneficiary of QE and EM central banks bought dollars to sterilise the appreciation of domestic currency, building foreign currency reserves and maintaining the link to the dollar.  That process will reverse if QE is reduced and EM central banks will sell dollars to support their currencies or maintain the peg.  We have seen this play out in the currency markets as the dollar weakens on heightened concerns of tapering QE rather than the reverse appreciation that one would expect.

Our conclusion from the QE tapering discussion is that whether intentional or not, the “trial balloon” from the Fed has yielded some vital market intelligence on the impact of an exit strategy to central banks around the world.  We can expect to see more of the same over time but believe that in the short term the negative feedback loop on the US economy, through the violent reaction in the MBS market will lead to equilibrium in bond markets at lower yields than we see in markets today.  The US economy, and the recovery in real estate is not robust enough to absorb a brutal move up in borrowing  costs and yields will moderate from current levels as investors find an appropriate equilibrium.

EM debt and currencies will recover from the recent sell off in response to lower US yields.  However, any relief will be relatively short lived and investors like the Fed, should take heed of the lessons learned over the past few weeks.

The bond bull market is over, each bear market rally will be an opportunity to sell and equities will only be able to progress in the face of QE fears if earnings revisions gain some positive momentum from stronger global growth.

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