KRUGER INSIGHTS THURSDAY OCTOBER 31, 2013

PLEASANT SURPRISE - It was certainly refreshing to see the Fed keep its cool on Wednesday and not overreact with an overly dovish statement in light of some concerning developments over the past several weeks. Overall, the tone of the Fed was much less dovish than the markets had been looking for, with no mention of any distress over the debt ceiling fiasco, and the elimination of a key phrase from the previous statement. “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.” The elimination of the “tightening of financial conditions” portion of the statement suggests that a Fed taper might not be as far out as the markets had been hoping for. It’s actually funny when you think about it. The stock market rallies to fresh record highs on news that the government shut-down and debt ceiling uncertainty has been resolved, and also wants to continue to rally on the hope that there is still a lot of uncertainty surrounding these issues that would deter the Fed from tapering any time soon. Quite the paradox I’d say.  

HAVE IT OR EAT IT – Bottom line – You can’t have your cake and eat it too. Somethings gotta give. In my view, stocks have run way too far way too fast, and the equity market is severely disconnected from reality at this point. We need to see a major correction here to allow for normalization and I believe this correction could be as much as 20%. As I have said in recent commentary, a profit is never a profit until it is realized, and all those market participants long the market over the past several months, will only benefit from these longs if they sell out of their positions. I think the materialization of this fact, along with the actual pricing in of a Fed taper will be what really starts to open a major liquidation in the equity markets in the days and weeks ahead. This in turn should weigh on correlated risk assets like the commodity bloc currencies and emerging markets. Elsewhere, in light of the above, I am still not convinced that USD/JPY is really ready to break out just yet, and we still could see some weakness there, Meanwhile, keep your eyes on the EUR/CHF cross rate as an additional barometer for risk appetite. Should this cross come back under pressure, we could see additional strain on risk assets. It is the final day of trade for October, so watch out for those end of month flows.