The "Bernank" Bashing

There's been a healthy sell-off in equities, commodities and gold. USD has bounced back against most other currency pairs. Here are my thoughts;

It is important to remember that the Fed is not a very good market forecaster, so the expectation now reflected in market prices, of the Fed reducing QE in the coming months, is still very uncertain. In this context, Bill Gross is still calling for year-end US 10yr sub 2.0% (now 2.4%).

Ignoring this uncertainty, Bernanke sent a very strong message to the market. He was very clear about when the central bank expects QE to actually end. Although he also acknowledged aggressively that the FOMC Target (Interest) Rate is unlikely to move for sometime, even if the unemployment rate is doing well. This is obviously an effort to prevent an excessive collapse in long-term bond prices.

What’s happening now, though, is that the market has had its recent moves approved, and it has been given permission to push further. (Whilst many had thought that Bernanke would have used this speech to calm markets after a period of relative volatility.) The affirmed trend is mainly relevant in long-end bond markets. I’d expect the US 10yr to start pushing back toward the historical range. In 2003, when the Fed Target Rate went to 1.0%, the 10yr traded down to 3.0%, but spent most of the “exceptionally low” rateera in the 4.0-4.5% corridor. With this in mind, the fair rate now is arguably in region of 2.5% or more (which is consistent with many macroassessments).

Thus, we can expect continued outflows from long-bonds in multiple regions and currencies. (Interestingly, Germany's 10 year Bund is also reacting, up to 1.65% now from 1.16% in early May.)

For the moment, the equity selling is equally determined. But it doesn’t feel panicky, and I have the sense that it is more because events justify taking profits ahead of the summer lulls (as we end 2Q13) rather than because of anything else.

As for FX, it seems to have rationalised, with USD strengthening against EUR (1.32), JPY (97.8) and GBP (1.547). This makes more sense than the negative USD move we'd been experiencing recently.

At worst case, I’d be looking for an 8-9% correction on the S&P 500 Index, and certainly I’m trying to use this opportunity to convince clients to increase their investment exposure.