Investor sentiment turns on more benign scenarios for Syria and Fed tapering

by: Georgette Boele

Sentiment in financial markets improved further on Tuesday as two key themes that started to play out on Monday continued to take shape. First, the assessment of a lower risk of a military intervention in Syria. Second, the prospect that a tapering of asset purchases by the Fed will be at a slower pace than previously assumed and could be coupled with additional forward guidance to cap rate hike expectations. Moreover, in the background, the global economy has continued to recover, which means that underlying fundamentals are becoming more positive at the same time as these negatives are fading. A strong batch of economic data from China, suggesting that economic growth is regaining some traction became the latest encouraging sign. In classic risk-on fashion, global equity markets rose, but Treasuries, Bunds, gold and the yen lost ground. At the same time, emerging market currencies have recently recovered sharply. The Brazilian real has gained a whopping 7% since the central bank announced its FX intervention plan on 22 August. The recovery of the Indian rupee started with a delay on 28 August, but has also regained around 7%. These moves are broadly in line with our central scenario of improving investor sentiment on the back of a sustained global economic recovery, though risks related to the Fed exit of course remain, and this topic will likely in any case lead to bouts of volatility from time to time. The missing part of the jigsaw is that the EUR/USD, which has remained elevated. This reflects that German yields have often even outpaced the rise US yields. We expect this to change as better-than-expected US data and dovish comments from the ECB increasingly come to the fore.