Home' Trinidad and Tobago Guardian : September 5th 2013 Contents Today, we at Bourse, will discuss
the US Federal Reserve and the
implications of tapering of its
bond purchase programme
later this year. We will review
the outcome of speculation on
the remarks of the Federal Reserve and its
effects on the global fixed income market.
Possibility of tapering
The financial crisis that began in 2007 was
an intense period of global financial strain,
leading to a deep and prolonged global eco-
nomic downturn. The Federal Reserve took
extraordinary measures in response to the
financial crisis to help stabilise the US economy
and financial system by reducing the level of
short-term interest rates to near zero, in addi-
tion to the US$85 billion bond purchase stim-
ulus programme. As the stimulus actions took
effect and the US economy begins to showing
signs of recovery, the Federal Reserve now has
the task of removing the extraordinary liquidity
According to the FOMC, the target range
for the federal funds rate below 0.25 per cent
will be appropriate at least as long as the
unemployment rate remains above 6.5 per
cent, and inflation is less than 2.5 per cent.
This communication has been interpreted by
the markets as the Fed likely ending the stim-
ulus program once the economy reaches 6.5
per cent unemployment and inflation is fore-
casted to be 2.5 per cent.
While these are guidelines, any interest rate
actions by the Fed in deciding when tapering
of the quantitative easing is required would
ultimately be based on the overall status of
Recent economic data has been pointing to
a recovery in the US economy and improve-
ments in business conditions. Economic activ-
ity expanded at a modest pace in the first half
of the year, with second quarter real GDP
growth coming in at a revised 2.5 per cent.
Manufacturing production expanded in the
second quarter, while auto sales and production
were near pre-recession levels.
Conditions in the housing sector are improv-
ing, as expenditures for residential investment
continued to expand in the second quarter.
Private-sector employment has also been
increasing, although the unemployment rate
was still elevated. Consumer price inflation
slowed markedly in the second quarter. Exhibit
1 shows the status of US economic indicators
and a forecast through 2014.
As seen in exhibit 1, US economic growth---
although volatile through the end of 2012---
is forecast to continue its upward trend through
2014. In addition, unemployment levels are
projected to continue to decline, while inflation
is anticipated to be maintained at or below
the two per cent range. Given these economic
trends and the recent communications of the
Fed, it seems that tapering of quantitative eas-
ing measures is set to begin.
The FOMC presently believes that real GDP
will increase in the second half of the year.
Part of this projected increase reflects the
expectation that the drag on economic growth
from fiscal policy would be smaller in the sec-
ond half as the pace of reductions in federal
government purchases slows and as the
restraint on growth in consumer spending
stemming from the higher taxes enacted at
the beginning of the year diminishes.
On the September 17 and 18, 2013, the
FOMC will hold a scheduled meeting to discuss
the status of the economy and vote on tapering
of the stimulus programme. Economists and
analysts suspect that conditions are sufficient
and the Federal Reserve is likely to begin taper-
ing by the end of 2013.
The committee indicated numerous risks
around the forecast. Among the downside
risks for economic activity were the uncertain
effects and future course of fiscal policy, the
possibility of adverse developments in foreign
economies, and concerns about the ability of
the US economy to weather potential future
adverse shocks. In addition, the present sit-
uation regarding Syria and the potential for
military action could result in increasing oil
prices with a negative effect on global growth.
Federal Reserve and global fixed
During the FOMC July meeting, the Federal
Reserve indicated they will likely be ready to
begin rolling back the unprecedented stimulus
as early as September. The result was an out-
flow of investments from emerging markets
back to the US, in both equity and fixed income
The panic "rush to the exit" of investors
has also placed pressures on many global cur-
rencies, with most emerging market currencies
depreciating versus the US dollar.
Tapering, in essence, is the clearest signal
of an end to low USD interest rates across
global markets. Consequently, US Treasury
yields, the benchmark of US-dollar denom-
inated fixed income markets, have been on
the rise. Exhibit 2 shows the current US Treas-
ury yields and forecast through 2014.
As expectations of USD interest rate increases
strengthen, investors will demand higher yields
on all USD-denominated fixed income secu-
rities. The result of rising yield demands is a
pullback in bond prices, regardless of cred-
The Bloomberg USD Emerging Market Cor-
porate Bond Index, which is a market-value
weighted index engineered to measure cor-
porate bond performance of USD fixed-rate
corporate bond issues in emerging markets,
declined by 7.2 per cent to 128.93 from a peak
of 138.939 in early May 2013.
With the rapid reversal in yields/prices, it
would appear that much of the effects of a
rise in US interest rates have been priced into
fixed income assets. The market, after its initial
knee-jerk reaction, should likely settle at cur-
rent levels (at least over the short term).
Significant potential fixed income oppor-
tunities exist for the investor with patient cap-
ital. Fixed-income valuations, as measured by
the Bloomberg USD Emerging Market Cor-
porate Bond Index, are now at their most
attractive levels for the past 12 months, allowing
the investor to add high quality fixed income
to a well-diversified portfolio.
As market uncertainties rise, "locking-in"
returns via bonds will become an increasingly
attractive prospect to investors. With regards
to investment strategy, the investor should
ladder fixed income securities within the port-
folio, minimising the effect of volatility of
prices caused by interest rate movements.
Incremental investing throughout the rate
cycle is an important investment discipline,
that is, periodically accumulating bonds as
rates continue to rise.
Finally, investors should also consider moving
up the credit rating scale as markets afford
this opportunity. In other words, the investor
will receive better returns for accepting lower
bond risk (higher-rated bonds) as rates rise.
As the US and the rest of the world slowly
sail out of the economic doldrums, the invest-
ment landscape will remain a dynamic one.
Markets will continue to change and the attrac-
tiveness of different asset classes will contin-
As always, investors are advised to seek con-
sultation from a qualified investment adviser,
like Bourse, before undertaking any investment
ventures, as we assist in adding the most value
to your investment decisions.
BUSINESS GUARDIAN www.guardian.co.tt SEPTEMBER 2013 • WEEK ONE
Bourse Securities Ltd
Weekly Market Review
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three years immediately preceding this document; or
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document, which may have been obtained from or
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