The FOMC statement last night was broadly unchanged but Bernanke set out a clear timetable for how QE would be wound down starting later this year and ending next summer if the labour market continues to improve as they expect. He used the familiar central bank driving analogy of easing off on the gas as opposed to hitting the brakes and stressed there would be a considerable length of time between the end of QE and the first rate hike. My feeling is still that the Fed will end up tightening later than this all suggests. Lead indicators are weak and the markets will want to force the Fed to take the drop in inflation more seriously, probably via a further large drop in commodity prices.
The most noteworthy thing about the initial market reaction is the strength of the US dollar despite a further drop in risk assets. This suggests the counter-intuitive dollar weakness we have seen since Fed tapering was first raised has run its course and was mostly likely a temporary phenomenon related to the selling of dollar-linked assets in the emerging markets.
In terms of investment strategy, we will stay overweight the US dollar but we are likely to further deepen our underweight positions in bonds and dollar-sensitive commodities including gold, off hard today.
We are likely to maintain a small overweight position in stocks in aggregate. Investor sentiment was already depressed before the Fed meeting and in the long run stocks are much less exposed to the risk of tightening than bonds are. We will stay overweight US equities, where we see good fundamentals, while moving further underweight emerging market equities.
Japan could come out of the current sell off looking good. Sentiment towards Japan is at a very low ebb but dollar strength should trigger the next wave of yen weakness, we expect Japanese exports to the US to remain strong and there are increasing signs of a pick up in activity at home.
Trevor Greetham is Portfolio Manager and Asset Allocation Director at Fidelity.
