Thursday, May 23 2013
There were some significant moves in markets overnight with treasuries and gold falling and stocks retreating as the US Federal Reserve minutes were released and Bernanke gave his Joint Economic Committee (JEC) Testimony to the US Congress in the afternoon. The catalyst for the pullback was some comments regarding the potential for quantitative easing to be unravelled.
Chairman Bernanke’s testimony to the JEC raised the possibility that the pace of Quantitative Easing (QE) purchases could potentially be tapered “in the next few meetings” if the outlook for the economy continues to improve but also noted that the next move in the purchase rate could either be up or down. He highlighted the possibility of holding assets to maturity, in line with the recent trend in Fed communication on this topic.
- The most notable statement made by Bernanke during the Q&A session was that the Federal Open Market Committee (FOMC) could potentially cut the pace of QE purchases “in the next few meetings,” although this was predicated on a continued improvement in the outlook for the economy and confidence in the sustainability of that improvement. He also stated that the purchase pace will depend on incoming data and that the FOMC could either raise or lower the pace of purchases in the future.
- On the strategy for winding down the Fed’s portfolio, Bernanke noted that the Fed could exit without selling securities (in contrast to the June 2011 exit principles which prescribed asset sales), consistent with the recent trend in Fed communication on this topic.
- Bernanke’s prepared remarks were very much in line with recent communications from the Fed leadership. He acknowledged the gradual improvement in the labour market, but stressed that the labour market remains weak and allocated a considerable amount of time to discussing fiscal drag. Bernanke reiterated an argument which he has made in the past, that raising interest rates prematurely could choke off the recovery, ultimately resulting in a longer period of low interest rates.
We see a number of implications from these comments:
- The Federal Reserve will keep interest rates low to support the economy until we see a sustainable recovery. This will be broadly supportive of the US economy.
- However we are likely past the lows in terms of bond yields and the US$ with markets likely to anticipate an unwinding of QE. This means those companies who earn US$ and benefit from higher bond yields will likely have strong support. For our portfolios this includes QBE, Macquarie Bank, Brambles, Sonic Healthcare, Ansell, Crown, Henderson’s and to a lesser degree Wotif and Lend Lease.
A softer A$ and higher bond rates will likely see some weakness in the defensive yield segment that has been strong over the past year. The key sectors include property trusts, banks, Telstra, utilities and food retailers. We have been underweight this segment of late but retain an exposure to banks. These sectors contain some very strong companies with solid yields. Weakness in these companies will likely be from offshore investors selling on concern of the currency eating away their return. This flow driven trading will likely play out reasonably quickly and could throw up some opportunities to enter some strong yielding companies at more attractive valuations.
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