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Prospects Weekly: Equity markets worldwide initially reacted positively to the "no-tapering" decision by the US Federal Reserve on 18 September, but later gave up most of their earlier gains, particularly among stressed economies.

The stock market rebound triggered by the US Federal Reserve decision to delay the scaling back of its asset purchase programmes was short-lived. In those developing economies most impacted by initial tapering concerns, renewed focus on economic fundamentals led to a significant reversal of earlier gains. Further increases in global interest rates are to be expected, making it urgent for policy makers to address ongoing vulnerabilities. Maize and rice prices have dropped to 3-year lows on improved crops, but wheat prices remain steady and stock levels low.

Equity markets worldwide initially reacted positively to the "no-tapering" decision by the US Federal Reserve on 18 September, but later gave up most of their earlier gains, particularly among stressed economies. For developing countries as a whole, stock markets were a modest 0.5% above their pre-announcement levels as of September 25, and 4.7% below their mid-May peak. Performance across countries was varied as markets appear to be paying renewed attention to country-specific factors. Although countries with substantial current account imbalances registered some of the strongest initials gains, following the announced postponement, many have since fallen again, including Indonesia, Turkey, India and Brazil. Among countries most affected by initial tapering concerns, South Africa stands out as one whose stock market has outperformed, in part because of recent indicators pointing towards stronger industrial activity and confidence.

Additional developing-country portfolio adjustmentswill occur when extraordinary monetary policy is eventually withdrawn and global interest rates rise. The steady purchase of government bonds by central banks (major central bank asset holdings have increased from about 8% of global GDP in 2008, to around 15% today) since the beginning of the crisis helped lower long term interest rates, which in turn pushed investment toward higher yielding developing country assets. In May, global monetary conditions started to tighten as market participants began to discount an eventual scaling back (tapering) of quantitative easing. In the absence of any specific action, the unexpectedly sharp reaction of long term US treasury yields and their term premium component likely reflects the major role that the Fed has come to play on the long end of the T-bill marketrecently. The spike after May undid about half of the decline in term premia observed since the onset of quantitative easing. Further adjustments and pressure on developing country assets can be expected when tapering actually takes effect.
Maize and rice prices have dropped to 3-year lows on ample supplies. Maize prices are down 30% since May, reaching the lowest level over the past 3 years. The US Department of Agriculture estimates this year’s maize crop to be 11% higher than 2012/13, increasing the stocks-to-use ratio (S/U) to 16.3%--the highest since 2009/10. Rice prices have also come under pressurebecause ofimproved supply prospects and the release of some stocks by the Thai government. They have fallen 13% since May and are now at theirlowest level since September 2010. Price risks on both maize and rice are on the downside, the latter depending on further Thai stock releases. Wheat prices have declined marginally (down 6% since May) but are still high by historical standards. Moreover, risks for wheat prices are on the upside, given that the grain’s S/U ratio remainsat 25%--its lowest level since 2008.

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