Simpatico, For Now…
The FOMC Statement and Conditions Within the U.S. Markets and Economy
By Steve Van Order, Fixed-Income Strategist
Through January 30, emerging market (EM) stock funds lost over $12 billion, and EM bond funds had a $4.7 billion run-out. At the country level, the reasons for this generally include some combination of economic and trade imbalances, political and social strife, poor economic and/or central bank policies, and low central bank reserves1. Recently, the proximal cause for big EM selloffs has been a pullback, or reversal, of policy accommodation by the Fed. The latest version of EM turmoil, however, can only be partly blamed on the Fed. Concerns about slowing growth in China and less liquid times played bigger roles. Interestingly, the tumult in EM did not even merit a mention in the new FOMC policy statement, and it became clear that unless EM turmoil starts to broadly destabilize U.S. financial markets, we would not see commentary on troubles overseas in the policy statement.
In January, U.S. Treasury yields benefitted from the flight-to-quality and, after starting the year above 3%, the 10-year T-note yield fell to 2.66%. Any investment named "U.S. Treasury" had a good month. The markets also received a much-needed correction of the gap between stocks and bonds, as last year the gap between equity and debt of U.S. corporations was the largest in 41 years. Without the EM turmoil, the ten-year T-note yield might have stuck around the 3% area throughout January.
And the FOMC statement on January 29 hewed to the "normalization expectation." The committee noted continued improved economic data, and that the economy should grow at a "moderate" 3% pace. The $10 billion QE taper was no surprise, and neither was continued guidance that the pace of tapering would be measured. Despite the presence of a few hawks (Fisher and Plosser) on the voting rotation this year, there were no dissents on the last policy statement of the Bernanke era. The Fed's steadfastness during a time of elevated foreign markets volatility was expected, as there was no material spillover from EMs into U.S. financial markets that endangered prospects for U.S. growth.
In fact, we appear to be quite far from that kind of threat, as evidenced by the recent resilience of U.S. credit spreads while EM spreads spiked upward. Credit spreads will continue to be vulnerable to widening if EM turmoil sticks around, but should remain far from levels suggestive of a U.S. credit-market disruption. While U.S. markets were affected by EM turmoil in January, U.S. credit market returns were just fine. U.S. stocks had their biggest monthly drop since May 2012, but as of Friday morning the drop from the intraday record high was not even half of a "correction" (which typically is 10%). Taking into account the resiliency of U.S. markets during EM turbulence, the FOMC statement was quite simpatico with conditions within the U.S. markets and economy.
This commentary represents the opinions of the author as of January 31, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.
1. Low foreign exchange reserves hamper a central bank's ability to defend the local currency from attacks.