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Article / 13 September 2012 at 6:25 GMT

FOMC will do more, not less....

Chief Economist & CIO / Saxo Bank
Denmark

Fiscal Cliff - the game changer

This week had three event risks: The German Constitutional Court ruling, the Dutch election and now today the FOMC meeting. Two down, one to go....and this one could be "the surprise".

The market is expecting no major change from the Federal Reserve - at most a change to the outlook to extend the expectations for low rates out to include 2015 from the current horizon of late 2014, but...I think we may be in for a surprise. The minutes, the 'leaks', the tone and the focus inside the FOMC have changed for two reasons:

1. The dual mandate has become a single mandate: jobs, jobs and jobs. Bernanke is frustrated that his monetary experiments have gotten him practically nowhere in terms of changing the dynamics of the US job market. The US economy has stabilised but not found a new growth path. The Fed wrongly continues to believe that unemployment is cyclical, we have long argued that it's structural (wrong skills, wrong locations, poor average education).

2. The fiscal cliff: If nothing is done, the price tag on the fiscal cliff is 3-4 percent of negative GDP due to the automatic budget cuts and overall austerity. This would be good for the fiscal deficits, but as we saw with the Club Med in Europe, the cuts would take US growth to the brink of - even into - a full-blown recession. The political negotiations will quite possibly reduce the height of the fiscal cliff, but considering the shenanigans of last year's debate, there is a real risk that this will end in a compromise in which GDP is still impacted by 0.5-1.0 percent of GDP. (Which is about minus 100 points in the S&P.)

In short, more Fed easing is more likely as the Fed thinks it must soften the blow to unemployment and growth from the fiscal cliff.

As for what the Fed will do, we may see unsterilised asset purchases, an extension of the exceptionally low rates language to 2015, and maybe even more explicit policy targets. In other words, this could be the full blown QE3.

The market looks at history and thinks that the Fed won't ease here because the stock market is not down and the US economy is humming along nicely. I certainly believe that the Fed should hold off on further easing, as my number one premise for creating positive growth is to 'do nothing' for years and let the micro-economy adjust and take over from the macro policy mistakes. But Bernanke and his friends around the world are Keynesians, they have an unshakable academic and dogmatic belief in their own abilities to save the world, and most importantly they don't want to be blamed for not doing enough - with Bernanke's term running out at the end of next year and with a known and long lag before policy takes effect, Bernanke could also be thinking in terms of both his legacy and/or his reappointment.

Policy makers and central bankers are once again throwing their shoulders to the sisyphean task of Keynesian extending and pretending in a balance sheet recession. This week, China announced USD 100 billion worth of fiscal stimulus, Europe agreed to yet another rescue 'mechanism' and the US will print more money. What is this - 2008 again? Let us not forget Einstein's immortal words: "insanity is doing the same thing over and over and expecting different results."

The market reaction to this will be higher gold (test of 1800?), a weaker US Dollar (EURUSD of 1.3150?) and a test of stock market highs (1450/60?).

I do, however, still think this is the fifth and final wave of the cycle, meaning I will fade any major moves sooner rather than later - monetary policy's ability to change the macro-economy stopped two years ago. This week we may see the end of its ability to take stock and risky assets higher. There is only one cheap asset left in the world: money, and that's a warning signal worth listening to.

Trades over the FOMC: we will (STST Steen Macro), buy a Friday Gold call, but more on that later. We are long EURUSD as per yesterday's recommendation, having taken a loss in long AUDUSD.


Steen

6y
bvlaerhoven bvlaerhoven
what about he impact of another round of QE on disposable income. Shouldn't that be of the key factors in the decision whether to QE or not?
6y
F L F L
The path from QEx/MBS to disposable income growth is very long at best.
That is, how exactly offloading banks from questionable MBS would help wages or employment?

Observe that interest rates are already low, tiny, and repressive to savers, which reduces their ability to spend and induce employment...
The US gov is deficit spending regardless these QEs (so far).

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