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What Follows the Taper Rally?

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Thursday, December 19, 2013

Stock markets in Japan and Europe followed Wall Street’s incredible reaction to the Fed’s measured Taper announcemen Wednesday afternoont. The bond market's reaction was lot more subdued and appears reflective of a wait-and-see mode. Pre-open sentiment today is a bit soft, but nothing unusual there given the strong gains in the previous session.

The Taper decision accompanied assurances that the FOMC planned to keep short-term interest rates at current levels for an extended period. The emphasis on ‘forward guidance’ was expected and appears to have done the job, for now at least, of articulating that ‘Taper’ and ‘Tighten’ were two distinct things.

The Taper plan unveiled Wednesday afternoon provides a measured roadmap for an end to the QE program by the end of 2014, with the Fed keeping a close eye on the economy. If the economy continues to improve, the FOMC will keep cutting back on bond purchases at each meeting. And if there are questions about the economy, they may skip a ‘meeting or two’ in making any cutbacks. But the overall path is clear. The Fed doesn’t envision touching the Fed Funds rate through 2015, ‘well past’ the unemployment rate falling below their prior target of 6.5%.

A lot will depend on how the bond market behaves in the coming days. Treasury yields didn’t show the type of reaction to the Taper announcement as the equity markets did and appear on track to keep moving towards the 3% level on the 10-year maturity. As the dust begins to settle on the Fed outlook, the stock market will likely take its cues from the bond market. And the bond market’s reaction will be a function of confidence in the Fed’s ‘forward guidance’ and assurances about the future. Stocks will be unable to sustain the positive post-Taper announcement mood if long-term treasury yields don’t stay adequately anchored.

In corporate news, Facebook (FB - Free Report) is planning a secondary stock offering and Darden Restaurants (DRI - Free Report) is contemplating separating its Red Lobster chain through a spin-off or outright sale. Facebook’s secondary offering announcement of 70 million Class A shares, a big part of which belongs to Mark Zuckerberg, will likely keep the stock under pressure in today’s session. The company had all along envisaged doing a secondary offering, but the plan was apparently delayed by the stock’s weakness following the botched IPO. But with the stock almost doubling this year and on track to join the S&P 500 index, they seem confident of pulling off the stock sale.

Sheraz Mian
Director of Research


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