Global financial markets were largely in a risk averse mood for most part of last week and through the first half of this week, ahead of the FOMC decision by the Federal Reserve. Global investors were largely in a risk off frame of mind, and equity markets and riskier assets came under pressure.

Sentiment was soured by lingering credit concerns in China together with another bout of turbulence in emerging market economies. Emerging market currencies plunged to record lows. In fact, last week the Argentinian peso recorded its largest decline in a decade while the Turkish lira fell to record lows against the euro and the dollar on Monday. Other currencies like the South African rand and Russian ruble were also under severe pressure.

Investors grow increasingly concerned that the excess cash which was fuelling growth in the so-called emerging economies will be pulled out, as the Fed continues to withdraw its stimulus package. While in China, tightening credit conditions were threatening to curb growth in high-risk lending which added to concerns that the world's second-largest economy could slow further. However, despite the relentless pressure, analysts do not believe that the current turbulence could blow into a full-fledged crisis.

In fact, by Tuesday most of the currencies under pressure had already bounced back from their lows on expectations that developing countries would tighten policy. On Tuesday, Turkey’s central bank governor vowed to fight spiralling inflation and the crumbling lira by raising expectations of an imminent aggressive rate hike. Analysts were predicting as much as a 225 basis point hike. This relieved some pressure off the emerging bloc.

The lira jumped more than 7 percent off its record lows on Monday, while the South African rand and the Russian ruble both pared some losses. Moreover, the MSCI emerging equity index rose half a percent on Tuesday after dropping to a four and a half month low on Monday.

Yen buoyed by safe-haven flows

As we mentioned, the imminent decision by the Fed in this week’s FOMC meeting was the biggest driver of the cash outflow from emerging economies. Anxiety and increased concern about emerging economies buoyed demand for the safe-haven appeal of the yen. The Nipponese currency rallied strongly towards the back end of last week and remained buoyant on Monday. However, forex investors were hesitant to position themselves aggressively against the dollar ahead of the Fed’s two-day meeting which started on Tuesday.

The Fed is widely seen as slashing another $10 billion from its quantitative easing program, and also likely to upgrade its assessment of the economy. Expectations for more tapering by the Fed also added pressure to equity markets, which performance is fuelled by the abundance of ultra-cheap cash by the Fed. Wall Street shares slipped further easing away from record highs hit earlier in the month.

USD/JPY plummeted to 101.92 last Friday, from the year’s peak of 105.44. EUR/USD climbed again above the 1.3700 mark last week, and now trades around the 1.3650 as we head towards the Fed outcome. The buck should continue to be supported as long as the Fed continues with their tapering drive.

Fed tapering may spark more risk aversion; Will USD/JPY come under pressure?

EUR/USD will likely drop back towards the 1.3500 levels if the Fed reduces its asset purchases further but the fate of USD/JPY may not be so straightforward. In fact, more tapering will likely result in more pressure on riskier assets and increased support for the safe-haven yen. Therefore the pair’s rise may be capped in the near-term unless we get any more surprises from the respective central banks. On the other hand should the Fed stay put, we may well see USD/JPY plunge lower towards the psychological 100 level, and EUR/USD back above 1.3800.

Pound eases as GDP growth matches expectations

Sterling weakened from a multi-year high on Tuesday after a report showed UK growth matched analysts’ expectations for the fourth quarter. The report showed UK GDP rose 0.7 percent in the fourth quarter as expected and 2.8 percent annually. The pound had touched a two and a half year high against the greenback at the start of the week. Cable has been strongly supported in the last few months as economic conditions in Britain continue to improve.

GBP/USD hit 1.6668 last week, its strongest since May 2011. After what looks like a mild technical correction, the pair should resume its uptrend to test 1.6750. EUR/GBP is on a downward path and may retest the 80 pence level in the near-term.

Technical Key points: EUR/USD is bearish, target 1.3300, key reversal point 1.38. EUR/GBP is bearish, target 0.8050, key reversal point 0.8600. USD/JPY is bullish, target 105.00, key reversal point 97.50. GBP/USD is bullish, target 1.6700, key reversal point 1.5700. USD/CHF is neutral. AUD/USD is bearish, target 0.8750, key reversal point 0.9750. NZD/USD is neutral.