FX Alpha 17 September 2013

Tapering – What’s priced in for the USD?

Markets have priced in the Fed tapering by a small amount. The risk is not just that they do more rather than less but also a change of forward guidance criteria.

Coming into the Fed’s meeting this week markets have priced in a modest tapering of QE3. 10 Yr yields have rallied over the summer and now trade around 2.80%. The USD has been given the benefit of the doubt by markets (Chart 2) and trades at levels below what might be sug-gested on the basis of relative liquidity policy. The decision to taper is not based on an im-provement in US economic data alone. Fed members are no doubt concerned about the risks posed by a balance sheet that is now coming close to $3.4 trillion. Tapering in this sense is clearly justified and expected. There are two dynamics to consider: one is if the Fed does more than the market expects (they could hardly do less!) and the second is a change in forward guidance criteria.

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