U.S. economic strength likely to see Fed continue tightening path despite growing financial vulnerabilities, says ANZ Research

The United States’ economy and still stimulatory financial conditions will likely see the Federal Reserve continue its tightening path despite growing financial and external vulnerabilities, according to the latest report from ANZ Research.

Emerging market equity indices are off almost 20 percent this year, while advanced markets are down around 6 percent. The US bourse has fared better than most, being flat. The turmoil is in part triggered by rising real US Treasury yields amid a reassessment of Fed pricing. A number of other factors continue to weigh on risk assets, including slowing growth, slowing central bank asset purchases and geopolitical tension.

In addition, there has been a rise in the term premium, likely reflecting a withdrawal of Fed liquidity. From October 2018, the Fed is at peak flow reduction of its balance sheet, at USD50bn a month. In February we highlighted the risk of heightened financial market volatility amid rising inflation expectations and thus Fed tightening.

Also, a recent Fed study highlighted that US firms repatriated just over USD300 billion in Q1 2018. This represents around 30 percent of the estimated stock of offshore cash holdings. The study looked at what 15 of the largest non-financial firms, which accounted for 80 percent of the overseas cash holdings, did with those funds, the report added.

They found that share buybacks spiked dramatically for these firms, with the ratio of buybacks to assets more than doubling in Q1 relative to the previous quarter, while buybacks for other firms changed little. In dollar terms, buybacks increased from USD23 billion in Q4 2017 to USD55 billion in Q1 2018.

"It’s possible that higher US yields in combination with slowing EM growth may continue to weigh on EM markets. The Fed is not about to come to the rescue of financial markets – not yet, anyway," ANZ Research commented.