Looking into the Fed’s crystal ball
CHARLES SCHWAB
LIZ ANN SONDERS
We believe monetary policy is largely on hold for the near to medium-term. It’s unlikely the Fed will begin to let its balance sheet shrink; as such, “QE 2.5” – reinvesting proceeds from maturing Treasuries to maintain the level of its balance sheet – would be considered a go once QE2 ends this month. Given the US and global economy’s soft patch, expectations for the first actual rate hike by the Fed have been pushed to mid-2012. It may be premature to set target dates for the first hike because the Fed is truly data-dependent and driven by their dual mandate. In other words, if employment growth were to improve meaningfully and inflation expectations were to pick up uncomfortably, the Fed might be moved to at least hint about rate hikes sooner than what is built into expectations.
As for whether QE3 is on the table, Fed chairman Bernanke has already said explicitly that the bar is very high.
In our minds that bar would only be hit if deflation risk increased markedly from here and the unemployment rate were to move meaningfully higher from here. In other words, both of their mandates would likely have to be breached for the Fed to consider QE3 a necessary remedy.
IG INDEX
CHRISTOPHER BEAUCHAMP
Ben Bernanke does his “Meet the Press” act for the second time today, when he will take questions on the Fed’s view of the state of the US economy. As it stands, the Fed is stuck between a rock and a hard place; the US economy is not yet strong enough to withstand tighter policy, nor is it weak enough for QE3. The most likely course of action is for the Fed to refrain from any changes to policy, preferring instead to see how the current “soft patch” in the US economy plays out.
A decision to stand fast would most likely result in a rally for the US dollar, due to diminished expectations of more money printing, although this could rapidly peter out as investors realise rate hikes are still some way off.
Continued loose policy will give a lift to both equities and commodities, but perhaps the longer term driver remains the crisis in Europe. If people continue to shift back to US Treasuries as a safe haven, the US dollar could make gains regardless of the Federal debt ceiling problem that looms on the horizon, and this could contribute to further losses for stocks.
GFT FOREX
KATHY LIEN
With US economic data still very weak, the Federal Reserve will have no choice but to keep monetary policy easy. The idea of another round of quantitative easing (QE3) has been floated, but the deterioration in US data has not been severe and consistent enough to warrant such a nuclear option. QE2 received a significant amount of opposition both inside and outside of the Federal Reserve and QE3 would make Bernanke even more politically unpopular. The Fed has decided to go with their initial game plan of ending asset purchases but keeping the size of the balance sheet unchanged going forward by reinvesting principal payments. The more interesting question to consider is what could happen to the dollar once QE2 is completed at the end of this month. To answer this question, we can examine how the dollar behaved when the first round of quantitative easing ended around April 2010. The dollar index rose 10 percent between April and mid June but over the next few months, it trended lower as investors considered the possibility of QE2. We saw a similar reaction in euro-dollar, which fell from $1.33 down below $1.20. Since more stimulus is not a serious possibility this time around, the end of QE2 this month could spark a dollar rally based on the prospect of higher yields along with less concerns about inflation or currency debasement.
CAXTON FX
RICHARD DRIVER
There is little pushing the Fed to tighten policy. The US is not suffering from the same price pressures as other economies and labour market improvement remains the Fed’s number one concern. Moreover, there have emerged serious question marks over the US economic outlook amid a raft of awful growth figures. The Fed and Bank of England policy outlooks are very similar; tighter policy can only be considered when sustained growth emerges. The threat of a double-dip recession in both economies remains realistic, and premature tightening could be the tipping point.
Accordingly, we are probably looking at the middle of next year for a Fed rate hike. Bernanke looks highly likely to maintain his “extended period” rhetoric with regard to the Fed’s current ultra-loose monetary policy. However, a third round of quantitative easing would probably only be resorted to if the US did fall back into negative growth. Bernanke is likely to stress the recent weakness of US growth and in the absence of any hints to future tightening, the US dollar looks likely to come under a little pressure. The dollar will remain weak for many months to come, but hopes for hawkish Fed rhetoric are so sparse that we are unlikely to see the greenback suffer any major losses for today at least.