Tapering is not tightening
Treasury yields fell, the USD weakened and equities rallied last week after FED Chairman Ben Bernanke stressed that tapering does not equate to tightening and reassured that monetary policy will stay accommodative in the foreseeable future. The FOMC may opt to hold interest rates near zero even after the unemployment rate reaches 6.5% if inflation stays low. Ben Bernanke added that the full impact of the USD85bil sequester cut that takes effect between April- September may have yet to be felt.
Consensus view is shifting backward with regards to the timing for QE3 tapering and rate hike. Ben Bernanke’s latest comments and investors’ shift in tapering expectation pretty much blends with DBS Research’s view.
Our economist expects QE tapering to start only after September 2013 and end beyond mid-2014. The FED has indicated that it uses 3 parameters to adjust monetary policy.
These are GDP growth, unemployment rate and PCE inflation. We note the following:
1. Core PCE inflation, which is the Fed’s favoured gauge, is running at 1.1% YoY that is half the Fed target. Furthermore, the figure is falling, not rising.
2. GDP growth declined to 1.1% (q-o-q, saar) over the past 2 quarters, half its average in the past 2 years
3. Unemployment has fallen by a mere 0.2% in the 9 months since QE3 was launched. If this gradual rate is to continue, 7% unemployment (where the FED expects to end QE altogether) would not be reached until August 2015, which 15 months later than what the Fed currently projects. A 6.5% unemployment rate – the threshold for raising Fed funds – would not be reached until June 2017, 2.25 years later than the Feb15 date the Fed currently envisions.
Furthermore, there is the risk that tapering may have consequence on the present nascent recovery in the housing market. The FED currently purchases USD40bil of mortgage bonds each month under QE3. It’s no surprise that the mere mention of tapering has sent mortgage rate up 100bps to 3.68% and mortgage applications down 41% in 9 weeks.
FED officials acknowledged that the central bank’s mortgage backed securities purchase program has helped the economy and it’s no surprise that some members urge a reduction in Treasury rather than mortgage purchase, when tapering starts.
Same message, different reaction
There is not much news that was said last week compared to the post June FOMC meeting press conference. Back in June, Ben Bernanke said that QE tapering is not automatic but dependent on GDP and unemployment numbers. He had added that any rate hike is still ‘far into the future’ and the FED might even aim to lower the 6.5% unemployment threshold before raising short-term rates (refer to Wired Weekly dated June 24th). ; In the immediate aftermath of the June FOMC meeting, US 10-yr treasury yield was at 2.41%, still lower than the current 2.54% level. Yet back in June, equity markets reacted negatively. This time round though, it’s a positive reaction. The FED said nothing much new between June and now. What’s different though is the market reaction while treasury yield is even higher now.
We thus stick to our view that while STI has touched a low at 3065 (13.1x blended FY13/14F PE) in June, near-term upside should be capped at 3246, which is slightly below the 13.9x (average) blended FY13/14F PE level at 3266. Concerns about the impact of a China slowdown on Asia, STI’s low single digit FY13F EPS growth and uncertainty surrounding QE tapering are likely to limit the current rebound upside in the near-term.
Time, or a return in confidence that growth is returning, is needed for STI to sustain a rise above this level. Project the 13.9x (average) 12-mth forward PE positions the STI at 3430 by year-end.
Publish date: 15/07/13