FED's Balance Sheet reduction still to be priced in by the markets?

FED's Balance Sheet reduction still to be priced in by the markets?

If taper tantrum resulted in May 2013  US 10 Y yields rising from 1.9% to 2.9% in 4 months, then the data dependent balance sheet reduction plan, laid down by the FED yesterday, has not had a remotely comparable reaction as yet. The fact that the May 2013 announcement had caught market unprepared as compared to a highly more communicative FED these days, should result in a far lesser move but still a 20bp up move in yields could be warranted.

The FED has potentially laid out a plan to reduce its $4.5 tr balance sheet by $500 bn in 2018, subject to data supporting the move. I don’t think that most of the market expected a 11% of a wind down so soon. To add to that the FED did not revise the inflation forecast for 2018 and 2019 lower suggesting that it expects data to support.

US10Y – US2Y treasury yield spread is near its lowest level since 2007 which shows that the market has been overly pessimistic about long term US growth prospects as against what the FED expects. US 10 Y yields therefore have the potential to rise further towards 2.25-2.30% (CMP 2.14%) taking the USD index towards 99.5 (CMP 97.3)

While we might see some uptick in yields today in the US session, over the next week I would target the following levels in various trades.

·        I would trade USDJPY from the long sides for 112 levels (CMP 109.76).

·        GBPUSD has the potential to move towards 1.2550 (CMP 1.27)

·        USDINR can move towards 64.75 (CMP 64.43).