Macro Wrap – Rate Sensitive Head Fake

by Enis September 19, 2013 7:55 am • Commentary

To get a sense for the Federal Reserve’s impact on global financial markets, look at the moves in emerging markets today:

  • The main Turkish equity index up 7.5%, up 20% from 2 weeks ago.
  • The main Indonesian equity index up 4.5%, up 15% from 2 weeks ago.
  • The main Indian equity index up 3.5%, up 10% from 2 weeks ago.
  • All 3 currencies are up 6-7% vs. the USD from 2 weeks ago.

These are massive moves.  Imagine you’re a businessman in Turkey, Indonesia or India.  You have to constantly manage your dollar-based liabilities, but the currency is moving 10% per month.  Or you are a consumer looking to buy a home.  If you close 1 month too early or 1 month too late, it can make a difference of 10-15% on the price of the house.  Or you are a corporate looking to borrow from the bond market – one release from the U.S. central bank can save or lose you hundreds of millions of dollars.

In short, the global impact of the Fed’s words and actions are incredibly far-reaching.  They affect consumers and producers in every corner of the world.  Even those who might not know it (like those clamoring on the streets on the back of higher food or energy prices).

Media outlets around the world (and not just those focused on financial news) now provide live feeds for Bernanke’s press conferences.  President Obama rarely gets such attention.

I bring all of this up because the Fed continues to emphasize that its job and its mandate is to focus on the U.S.  But its actions and words are making much more of a difference elsewhere.  What’s most surprising about the price action of the past 4 months in global financial markets is that the one price the Fed explicitly targets seems to be reacting the least of all.  The 10 year govt bond yield in 2013:

10 year government bond yield, Courtesy of Bloomberg
10 year government bond yield, Courtesy of Bloomberg

Yesterday’s yield drop did bring the 10 year yield below the 50 day moving average for the first time since May, but the rate is still 80 bps above where it was when Bernanke said the taper would likely be in the second half of this year.

While interest-rate sensitive sectors were some of the strongest performers on yesterday’s bounce (most notably, REITs and housing-related stocks), the plain fact of the matter is that rates are much higher than they were 3-6 months ago.  While the Fed would like to see long-term U.S. rates go lower, other asset classes and geographies are reacting much more violently to the central bank.

If that rate stickiness continues (regardless of whether the taper comes in Oct, Dec, or 2014), my hunch is that the rotation that we saw yesterday is more likely to reverse.  Financials and health care will once again attract funds and outperform.  Emerging markets and U.S. real estate-based investments will resume their descent.  Beware the rate sensitive head fake if rates don’t actually comply.