'Yellen likely to keep group vote policy, tapering path to continue' - John Kicklighter, DailyFX

   John
Kicklighter

PROFILE:
• Current Job:  Senior Currency Strategist for FXCM in New York.
• Career: Graduated from the Zicklin School of Business with a Bachelors degree in Finance and Investment. Specialized in combining fundamental and technical analysis with money management.

View profile at FXstreet.com

John Kicklighter is the senior currency strategist for FXCM in New York where he specializes in combining fundamental and technical analysis with money management. John authors a number of regular articles for DailyFX.com, ranging in topics from basic fundamental forecasts for the G10 economies and commodities to more complex subjects like the level of risk sentiment across the financial markets and the carry trade specifically.

John has actively traded since he was a teenager. His experience ranges from spot currency, financial futures, commodities, stocks, and options on all of these instruments for his personal accounts. John graduated from the Zicklin School of Business at Baruch College in New York with a Bachelors degree in Finance and Investment.

Do you expect new Fed chair Janet Yellen to stay on the tapering course set under Bernanke? What could convince her to adjust the strategy?

In the statement that accompanied the January 29th decision to Taper the Fed’s QE3 program for the second time, the market made note of the unanimous decision. In her last vote as Vice Chairman, Janet Yellen voted to maintain a trend of stimulus reduction that began in December. The new Chair is just as concerned with consistency to avoid market and economic volatility via monetary policy. She is likely to keep the ‘group vote’ policy approach that Bernanke championed before her. That being said, even the most dovish members of the Fed group have voiced their belief that turning the central bank off its path of stimulus de-escalation is a ‘high hurdle’. To turn Yellen and the FOMC away from their path, we would likely need to see a tangible risk of the US economy pitching back into recession (not just a mere correction) or a financial market seizure.

Since the beginning of the Fed's QE taper, emerging markets have been experiencing substantial capital outflows and a weakening of their currencies. Will these countries manage to keep their currencies stable as the taper progresses?

The emerging markets were ill-prepared for the inevitable shift away from limitless central bank support. Policy officials in these pained economies have implemented capital controls and ramped interest rates higher in a bid to stabilize their exchange rates, yet this effort will only prove fruitful should the markets themselves remain relatively stable. The problem facing the EM countries – much like global equities, high-yield exposure and other risky investments – is that the market plowed capital (and in many cases on leverage) into higher return assets in a bid to exploit conditions of extremely low volatility to overcome extremely low market rates. Deleveraging is a difficult – if impossible – situation to curb so long as emotions are in control.

How probable is a BoE rate hike this year?

According to the market, a BoE rate hike in 2014 is almost a sure thing. Their expectations have been well-supported by the strong economic recovery from a near-triple dip recession – and the labor and inflation rebound that have accompanied the underlying change. A steady improvement in the jobless rate is certainly important here, but the ‘cost’ column of the balance sheet is more persuasive a catalyst (as it was with the Fed’s decision to Taper). Inflation will likely be the critical measure here. We will find a far greater level of certainty of a 2014 or 2015 rate hike next Wednesday when the BoE releases its Quarterly Inflation Report as it will offer an opportunity for the group to update their forward guidance.

Why are US stocks so bearish now? Do you expect more bearishness in the days to come?

The market’s underlying conditions certainly feed a situation where bearish sentiment can turn self-generating. Record high ‘risk’ benchmarks, founded on record levels of leverage, with questionable growth forecasts, compared to historically low rates of return and 15-year low levels of participation. That is a flimsy fundamental situation. Yet, a market that is both complacent and blissfully ignorant of risks can remain that way until the momentum of fear starts a wave of repositioning. The Fed’s Taper may not have played out as a single-day market-wide plunge event, but it has certainly changed the backdrop starting with the Emerging Markets and other exceptionally risky assets. The concern is working its way up the scale of risky assets. This pullback has a far greater chance of turning into a lasting correction than most other instances of the past five years.

Why does the Euro hold levels against the USD in the current pro-dollar environment?

There has been a strong inflow of capital in to the Eurozone during the current of risk appetite that sent investors to the high-yields of the periphery (Spain, Italy, Greece, etc). Those yields however have deflated as a consequence of the strong capital inflows. So far, the threat of global financial market volatility seems not to have hit the threshold necessary for prompting foreign investors to repatriate their capital. However that is not a very high water mark. Should the market admit the reversal of sentiment is more permanent than another short-term blip on the radar, EURUSD will drop just as surely as the yen crosses.

Do you see the USD/JPY falling below the 100.00 mark?

There is a high probability of USDJPY dropping below 100. The opposing forces on this pair are the same as most other yen crosses – risk trends versus the Bank of Japan’s commitment to driving their currency lower. While we know the dollar is a safe haven – moreso than the yen in fact – the need to deleveraging overextended and under-performing carry trades in the yen crosses is a more immediate need than moving capital from local safe havens into the full liquidity of the US Treasury and money market system. So long as risk aversion stays engaged and the BoJ doesn’t ramp up expectations of a near-term expansion of its open-ended stimulus program; USDJPY will drop alongside its other yen cross counterparts. That said, USDJPY is unlikely to drop as far or as fast as other pairings that don’t carry the same safe haven properties as the greenback.