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Will the Fed risk tapering if Syria crisis remains on-going?



By Kathleen Brooks of Forex.com Will the Fed risk tapering if Syria crisis remains on-going?

Photo Credit:Reuters/David Gray



The last two days have been something of an eye opener for those who were blinkered by Fed tapering in recent months. The Fed has played second fiddle to the prospect of international military intervention against Syria for a suspected chemical weapons attack last week. Stocks have fallen, emerging markets have been under pressure yet again, Treasuries have risen and the oil price has spiked as geopolitical risks spook investors.

The fact that we are deep into holiday season is not helping matters, next Monday, 2nd September, is Labor Day in the US and volumes are typically very light in the lead up to this public holiday. When trading volumes are light geopolitical actions such as what is going on in Syria can cause magnified market reactions. But even if price action over the last few days has been an over-reaction the Federal Reserve is going to be watching events very closely as the US central bank looks to embark on its biggest shift in monetary policy for years in just 3 weeks' time.

The prospect of the Fed starting its tapering program if there are Western strikes against Syria in the coming weeks would be hard to justify, especially as investors are using the Syrian situation as an excuse to dump risky assets causing volatility to pop higher.

While tapering itself is actually a moderate policy tweak in response to a pick-up in US economic data, the market has got used to the Fed feeding it liquidity. While this round of tapering may be no more than USD 20 billion per month, leaving the Fed still purchasing USD 65 billion of Treasuries and mortgage-backed securities, the market is taking this to be the first step on the road to tighter monetary policies. People seem to forget that QE and low interest rates were only meant to be temporary; instead they have become the normal standard, with bankers, politicians and some in the business community fearing economic collapse if the Fed takes its foot off the printing press.

But could the Syrian crisis really disrupt the pace of Fed tapering? Yes: if the price of oil continues to rise. WTI, or US oil, has risen 18% since the end of June, this has been exacerbated by the Syrian crisis, when the prospect of Western intervention was first touted on 27 August, WTI jumped 6% in a matter of hours. With some on the Fed along with plenty of politicians, questioning if the recovery is strong enough to sustain Fed tapering, elevated oil prices could cause them to come out steadfast against a taper, calling for tapering to be pushed out beyond the September meeting until things in Syria calm down.

Balancing out the oil price rise has been the decline in Treasury yields as US government debt has attracted safe haven flows in recent days. 10-year yields have fallen more than 20 basis points as tension in the Middle East has increased. While this could ease some pressure on the housing market, 30-year mortgage rates jumped to a 2.5 year high last week, the Fed may choose to put more focus on the rise in oil prices because of the consumer impact - rising gas prices can have major implications for US consumer activity, and thus growth, going forward.

On the flip side of the yes argument, there is a case to be made that Syrian risks are limited. Even if there are air strikes the impact could be muted if the action is short-term and does not involve ground troops. China and Russia's support for the Syrian regime and opposition to action also may not be a concern, as neither country seems willing to escalate their displeasures with the US and UK's active approach to airstrikes.

If events in Syria are short lived then it is hard to justify the Fed delaying tapering when the market has been prepped to expect a slowdown in the pace of asset purchases and the economy is showing solid signs of recovery.

If Syria is dealt with quickly then it may be US events that could disrupt the timing of Fed tapering going forward. The late September deadline to reach a new US budget agreement is a major risk event, if there is no agreement then it threatens a government shut-down, which may cause the US debt-ceiling to be hit by mid-October, which threatens a US default.

The risks to a delay in the Fed taper program going ahead seem to be rising. While the Syria conflict is the most obvious reason to delay it, the real reason could be closer to home.

Kathleen Brooks is research director at Forex.com.

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http://www.zawya.com/story/Impact_of_Syria_crisis_on_Fed-ZAWYA20130830081533/