The battle of the taper talks
11 July 2021
Friday 9 July 2021
Shae Russell,
Group Communications Manager
In this week's market report:
‘The film ain’t always like the book’
The taper no one cares about but should
The taper everyone cares about but shouldn’t (yet)
How to tell the bottom is in for gold
Rick Rule: Silver’s run ain’t done
Dear investor,
Settle in folks…
…maybe time this one with your afternoon tea break…
…or the train trip home.
We’re two weeks on from the Federal Reserve Bank’s meeting that sparked the ‘taper talk’.
And mere days after the Reserve Bank of Australia (RBA) joined the ‘taper’ chat.
Right now, one matters more than the other.
Which one? I’ll get to that in a moment.
First, let’s check in with our traders.
Thoughts from the Trading Desk
Nick Frappell has taken the reigns on this week’s edition of Thoughts from the Trading Desk.
His trading ‘Spidey Senses’ are looking at Chinese growth, bond markets rallying, the Federal Reserve Bank tapering and the Aussie dollar, with Nick writing:
There are recent signs that the pace of Chinese growth may be easing and more Asian economies have seen their purchasing managers index (PMI) data move into ‘contraction’.
The spread of the Delta (and news of the Lambda variant) elsewhere has been ‘risk-off’ with the broad US Dollar Index (DXY) continuing higher, bond markets rallying and driving the yields in US 10yr Treasuries lower.
Of note, is the benign response to the recent taper talk from the Fed. This can only imply one of two things: Market expectations around tapering are so well conditioned that there is little scope for surprise. Or markets/the Fed are too relaxed about economic reopening and inflationary effects of the huge fiscal and monetary stimulus seen since early 2020. More on this below...
Before we dive into the taper talk, let’s go over Nick’s points on the Aussie dollar.
‘The film ain’t always like the book’
What began as a quick phone chat to get Nick’s thoughts this week, turned into a very long phone call.
There’s large chunks of today’s market update on a digital scrap pad. Sit tight though. Nick and I are working on how we can bring you into our ‘chats’.
Til then, we had two key takeaways to share with you.
The tapering no one cares about but should and the tapering everyone cares about but shouldn’t (yet).
The taper no one cares about but should however, impacts you directly.
You see, it’s easy to forget the Reserve Bank of Australia delved into the murky world of unconventional monetary policy in the form of yield curve control (YCC).
The RBA has been buying bonds to keep the 3yr Treasury rate at 0.10%. This $200 billion bond buying program has been running since September last year.
The July meeting just past however, was the meeting where the RBA told the market it was our turn to discuss when tapering would end.
This didn’t come as a surprise to most market punters. Instead, it was the move to ‘flexible and open ended’ tapering that did with the plan to reduce the bond buying program towards the end of the year.
All of which caused the Aussie dollar to get a little excited…
AUDUSD exchange rate
Minute chart
Source: Trading View
That’s a 0.70% peak to trough rally in the AUSUSD cross rate, moving from 75.46 US cents to 75.59 US cents. This is a large jump for currencies.
However, the proposal of ending our local version of tapering didn’t help the Aussie hold onto the gains. A few hours later the Aussie dollar fell back down. All the way from 75.98 US cents, to a six month low of US 74.17 US cents at the time of writing.
AUDUSD exchange rate - daily chart
November 2020 – present
Source: Trading View
The inability to for the Aussie to keep the gains is noteworthy, Nick said on the phone this week.
In saying that though, he’s not surprised in the moves from our currency. Suggesting the case for long term softness in the Aussie was evident earlier in the year too, telling me:
‘The Reserve Bank of Australia’s easy monetary policies have capped the Aussie dollar’s rise. It’s notable however, that the RBA’s tapering talk hasn’t supported the Aussie dollar.
‘I guess the “film ain’t always like the book”, or some other farcical and hokey phrase that I will beat to death and squeeze all the joy out of.
‘While we’re still on the Aussie dollar, the fact that it went largely sideways and then made lower highs in the March-June period while iron ore futures went back to over US$200 (AU$269) per metric tonne (mt), and copper pushed up from US$9,000 (AU$12,100) to over US$10,000 (AU$13,450) per mt suggested that the outlook wasn’t that positive for the Aussie dollar.’
The key point from Nick is typically strong moves from the commodities sector lifts the Aussie dollar. That didn’t happen this time.
The short version is, we can expect the Aussie to stick around these levels for now.
Though you probably already knew the Aussie dollar was weakening, didn’t you?
See, that’s the advantage of holding precious metals. They reflect the value of your currency. When the Aussie dollar gold price climbs, that tells you the value of the Aussie dollar is falling.
Aussie dollar gold price
Daily chart
Source: Trading View
Simply put, a weaker Aussie dollar is good for your precious metal portfolio.
The taper everyone is talking about but shouldn’t (yet)
Two weeks ago – a few hours after the Federal Open Market Committee (FOMC) ended — we chewed on the things the Fed said.
Mostly, the one thing they said: that it was time to decide what the end of tapering would look like.
Let’s be clear. The Fed didn’t announce an end to tapering. Nor did it say what it ending tapering would look like.
Only, that it was time to ‘discuss’ what the end would look like.
Cue the dramatic headlines that give you no context, coupled with a rather spectacular 6% dive in the US dollar gold price for the next seven days, selling off from US$1,878 to US$1,760.
Then the price of gold got stuck in the weeds as the ‘open shorts’ were triggered said Nick at the time.
The US stock market fared much better than gold.
Neither the Dow Jones nor the S&P500 were dinted as badly as gold. Both indices only losing a couple of percentage points. Followed by strong rebound to new highs.
Stock markets have clearly forgotten about the ‘taper tantrum’ of 2013. Back then, stocks dived and bond yields spiked on the threat of their biggest buyer (the Federal Reserve Bank) stepping away.
The ‘taper’ though, never actually happened.
Lousy communication from our mates at the Fed caused the markets to spit the proverbial dummy.
Central banks realised the fragility of markets in hindsight and know this time must be different.
The outcome of the 2013 market dummy spit means the Fed will take a near glacial approach to ending tapering. With Nick writing:
‘One interesting aspect of the 2013 tantum is that it’s really about miscommunication from the Fed, and some observers also think the market over-reacted because it didn’t have a yardstick with which to measure the change in policy.
‘The Fed didn’t taper at all – the reaction was to the possibility of bond yields rising as the biggest buyer stepped away and that caused the stock market to fall – partly as the discounted cash flow model for stock valuations would have suggested lower equity values as bond yields went up.’
Given the stock market largely ignored talk of ‘tapering’, it’s worthwhile being wary of using headlines as a source of information.
A look at the bond market confirms this.
The US 10yr Treasury bonds are rising slightly, but stable. (Bond yields increasing means interests are falling, they have an inverse relationship). Or as Nick put it:
'The long end of the bond market (US 10yr Treasury bonds) is fairly low in yield because the market isn’t convinced that Fed cash rate won’t get north of 2% in the next tightening cycle.'
We see his long term view on a monthly 10yr US Treasury bond chart:
US 10yr Treasury Bonds
Monthly chart
Source: Bloomberg data; Updata
‘See? Benign!’ Nick exclaimed. Adding that he expects the bond rally to continue for a little longer.
Again, Nick’s reinforcing the point that the bond market isn’t expecting tapering anytime soon. Further to this, Nick noted the Fed rate is unlikely to rise before tapering ends.
Tapering is expansionary monetary policy and therefore equates to easing. In more simple terms, this means increasing the monetary supply quickly by making credit more available to drive investments or consumption.
After the reactionary events of the 2013 taper tantrum there have been concerns the Fed would stop the flow of funds to bonds by selling part of its balance sheet. Nick reckons this unlikely, saying:
'One concern is that the Fed disrupts the bond market by selling part of its balance sheet – my take is that the Fed will adopt a passive approach to reduction and ‘allow’ the existing holdings to run down. That is hardly a controversial view of course.'
More to the point, the end of tapering is more to likely follow a sort of road map. Possibly like this suggests Nick:
Talk about tapering.
Start tapering.
Raise short-term rates as appropriate.
Run-off Fed Treasury and MBS (Mortgage-Backed Securities) holdings.
In other words, tapering will ultimately happen. But the Fed is going to hold the markets hand as it turns life support machine off.
How to tell the bottom is in for gold
We can put taper talk aside for now, because there’s good news for gold folks!
Like I said last week, the yellow metal is looking for bottom in this price cycle.
We know it’s around here somewhere…
…and it may be found sooner than thought!
Overnight some fresh insights from Metals Focus hit my inbox.
Their end of year analysis points to increased gold jewellery buying from India and China.
This is positive news as both countries have seen jewellery consumption disrupted by Covid. Though Metals Focus warn gold jewellery demand is unlikely to exceed 2019 consumption. Rather data is suggesting traditional gold buying markets are springing back to life.
Further to this good news, is China and India increasing their coin and bar purchases above 2019 levels.
We’re going to explore how Asian gold markets operate in more detail next week.
Until then, here’s your sound bite to tell your mates over the weekend: Asian precious metal demand provides ‘a floor or protection to prices during institutional liquidations’ says Metals Focus however ‘Western demand drives rallies’.
A floor for gold prices, coupled with a weak Aussie dollar is likely to make some precious metal portfolios look healthy. Make sure you’re prepared for the next leg up in gold.
Now, to close out today and ease into the weekend, let’s end the day with a chat.
Today Rick Rule and I discuss how to be patient during a long term gold bull market, Rick’s ‘go to’ people for market insight and we even touch on silver…
Until next time,
Shae Russell
Group Communications Manager,
For ABC Bullion