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The Week In Hindsight, 21 December 2013

The Federal Reserve took the plunge on Wednesday evening by announcing its intent to begin tapering from January. Markets responded positively with strong corrective moves to the up side after weeks of uncertainty which saw global indices driven lower over December.

The January taper will see the Fed’s purchases of mortgage backed securities and US Government Treasuries by $5 billion each per month. Going out with a bang, Ben Bernanke cited an improving economic outlook and positive momentum in jobs growth as the key drivers behind the decision.

When questioned about previous concerns over inflation, the outgoing chairman cited a lag between economic improvement and its effect on price pressures while repeating his previous assertion that monetary policy was on no pre-set course.

In short, should the economic recovery deteriorate then the FOMC would be just as willing to consider increasing stimulus again as it would be to consider tapering more as the recovery builds further momentum.

FTSE 100/DOW JONES NOVEMBER – PRESENT

The move by the Federal Reserve this week heralds the beginning of the end for an era of ultra low interest rates. Although base rates are likely to remain unchanged for some time, UK Gilts and US Treasury yields peaked at close to 3% during a sell-off in the immediate aftermath of the stimulus cut.

Treasuries and financing costs will be watched closely over the coming months. This is as any significant increases here have the potential to derail the recovery, should this become an issue then policy makers will be forced to act.

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FTSE 100 REVERSES LOSSES ON TAPERING AS UK UNEMPLOYMENT FALLS FURTHER TOWARD TARGET

The FTSE 100 received a double boost this week as the UK unemployment rate unexpectedly fell from 7.6% down to 7.4%. This caught the markets off guard and helped to stabilise both sterling and the FTSE ahead of Thursday’s FOMC statement. The move followed another surprise drop, this time in the UK inflation number which saw CPI fall to 2.1%, the lowest level since October 2012.

 FTSE 100 2013

DOW JONES THROUGH 2013

Each of these developments bodes well for the recovery and the prospect of an eventual rise in interest rates however, increased optimism comes ahead of a big week for the UK economy. The coming fortnight sees another round of Manufacturing, Construction and Services PMI’s due for release.

With each of these sectors having shown rapid expansion throughout the second half of the year, some could say that they now appear overextended. Should the expansion appear to falter in January then concerns could emerge of a slowdown in the economic recovery.  If this is replicated elsewhere in the world equity markets could be in for a tough time.

Given that western stimulus programs are now winding down, loose policy is unlikely to remain the predominant driver of markets for much longer; for this reason it is reasonable to assume that there will come a time when stocks are expected to justify their present valuations. Should economic conditions and financial results at the time fail to support this as possible then markets could potentially enter a period of correction and consolidation in response.

North American releases to watch going into the New Year will be; US payrolls, inflation data, housing and unemployment numbers. On home shores Services and Construction figures will be watched closely along with inflation and unemployment numbers.

The final week of December sees the US Consumer Confidence and Pending Home Sales figures due for release amidst what is likely to be thin trade. Most major UK releases are due during the opening week of January.