What the Potential Fed Taper Means To Stocks & Forex

DailyFX

Body: Article Summary: The financial world has been run by Quantitative Easing or QE since the credit crisis spawned in 2008. The question that has followed since the first launch of QE has been what will happen to the economy when it is time to scale back on QE. That is exactly the uncertainty that tapering has brought to the market and what will be covered here.

“Successful investing is anticipating the anticipations of others.”

-John Maynard Keynes

Today the S&P 500 was down about 24+ points on rather good economic news. That is the world we live in where markets around the world are on a form of economic life support known as Quantitative Easing or QE. With QE, the market get the support needed from a central bank like the Federal Reserve when the economy is doing poorly so in a sense, good news becomes bad news and bad news becomes good news because it means more support in the form of money is coming into the market.

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The repercussion of this story is that if support in the form of QE runs dry or begins to dry, then many investors will pull their money from the risky assets like stocks and stuff their money into a safer investment like US Treasuries. As you can imagine, in order to sell investments in a stock index abroad that would normally lead to a massive pile in Treasuries. However, money may not flow into treasuries like they normally do.

What Is The Fed Taper?

The Federal Reserve taper is the reference to the reduction in Quantitative Easing efforts that are currently supporting the US Economy. The prospect of the markets being taken off of “life support” has sent the 10-year U.S. Treasure Yield’s higher which is synonymous with the US Dollar weakening. The reason for the talk of the taper is that employment has perked up recently which the Federal Reserve has mentioned would be a guiding light and qualifier as to when the QE efforts ceased.

Effects of the Taper

The Taper leaves a lot of traders likely scratching their heads because the US Dollar is where they would normally run straight into when the SPX is dropping as it currently is. This is where thinking ahead comes into play about what your next move should likely be. Typically, when the global markets don’t want the US Dollar, there are a few currencies that are sought after. The two main safe-haven currencies are the Swiss Franc (CHF) & Japanese Yen (JPY) however the Swiss National Bank or SNB earlier this week stated that they will continue to cap the Swiss strength by intervening if necessary.

Learn Forex: The Dollar UP & SPX down Correlation is Unwinding

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The reasons for this breaking of correlation has to do with the taper in that traders are fearful that a further boost may continue to weaken the US DOLLAR in order to scare people out of hoarding money in safe assets and put it back to work in the economy again. However, if investors are less willing to invest in stocks at all-time highs what are their options?

Don’t Fear the Taper Opportunities

In a macro perspective there world is not void of opportunities there are a few green shoots. When the dollar gets dumped along with stocks the other hard currency that often benefits is Gold or XAUUSD. XAUUSD broke key resistance at 1350 today which may be the first of a large move higher if US Dollar weakness continues.

Learn Forex: The Dollars Pain Could Be Gold’s Gain

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There may also be opportunities to buy or go long the Japanese Yen. While past performance is not indicative of future results, the USDJPY has closed lower in the last 13 of 15 Augusts dating back to 1998. If US Dollar weakness continues and the markets seek safety over risk, we could make it 14 of the last 16.

Learn Forex: USDJPY Could Present an Opportunity to the Downside If Markets Tense Up

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Closing Thoughts

While we may not know exactly how the markets may play out if the tapper happens we can prepare. The way we can prepare is by taking a defensive trading stance by identifying potential trends and more importantly by identifying points which would nullify your stance. A great thing about having a plan like this is that not only will you be identifying where to exit the trade should the markets behave in a manner that shows you that your edge is not playing out but it will also reduce your trading stress.

Happy Trading!

-Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@fxcm.com.

To be added to Tyler’s e-mail distribution list, please click here.

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