The vital question of the moment is whether of not The Bernank will signal an intention of moving towards QE3 in his much-anticipated 'Jackson Hole' conference in two weeks. Citi's Tom Fitzpatrick believes "it would be irresponsible to do so and that we need a more 'responsible fiscal policy' which will not materialize as long as we have an 'irresponsible monetary policy' bailing policymakers out". However, what we think in this regard is totally irrelevant to this discussion for it is what we think the Fed thinks that is critical. Recent data seems to have been a little more supportive of the economy (on the face of it) and may lead the Fed to stay on hold in the near term (September meeting). This will almost certainly raise the bar extremely high for further easing as we head into the Presidential race proper. If this window closes then a move before December will be extremely unlikely barring a major financial/market/economic shock, since after the 9/13 meeting, there are no more meetings until 12/12. However this increases the danger of the Fed getting 'caught behind the curve' which must be balanced with the 'mistake' of one-monetary-step-too-far with very real inflationary consequences.
10 year yields today compared to the summer of 1993
and Gold resembles 2006 - after Gold corrected down from $730 to $542 - when the market consolidated but utlimatley rallied to new trend highs...
and Brent is breaking to new highs...
Tom Fitzpatrick, Citigroup: To QE Or Not QE:
from a Fed perspective
Recent data seems to have been a little more supportive of the economy (on the face of it) and may lead the Fed to stay on hold in the near term (September meeting). This will almost certainly raise the bar to moving extremely high as we head into the Presidential race proper. If this window closes then a move before December will be extremely unlikely barring a major financial/market/economic shock. There is no Fed meeting in November so after the 13 Sept meeting the window likely closes until Dec 12 without an “event risk” scenario materializing.
However this increases the danger of the Fed getting “caught behind the curve” in their objectives as:
- Small business indicators (the backbone of the U.S. economy) are deteriorating again (Bad sign for employment)
- Overall employment is not following a traditional recovery path and we are seeing
- Poor household survey
- Continued dropping participation rate
- Flattening out for initial claims
- 3 consecutive monthly rises in the underemployment rate
- A housing market recovery that still dramatically lags other recoveries at this point in the cycle is keeping the consumer (70% of the economy) suppressed
- Consumer confidence appears to be rolling over again. Historically this has had negative leading indications for the Equity markets in the months following.
- Consumer credit is starting to soften again
- Core inflation indicators (their mandate) are softening
- Food and energy rising on supply concerns are creating a negative “fiscal drag” feedback loop
- US yields starting to rise as people now start to believe that we will not get a move from the Fed in the near term adding a potential monetary drag to the “fiscal drag” (Double whammy as we get de facto fiscal and monetary tightening)
- A Middle East “tinderbox” that is very susceptible to a food price shock and a likely cause of an Oil price shock (as we saw in 1973-1974 and again in 1978-1979)
- ISM back below 50 again where Fed “normally” eases
- Negative short-term yields in core Europe and elevated peripheral yields still in place suggesting that strains are still just below the surface. Despite this the ECB made no accommodative moves at the last meeting but just “kicked the can” again. More Eurozone stresses are therefore likely “around the corner.” In addition the weaker EUR will exacerbate the Food and Energy price rises in Europe.
- Slowing China economic data and rising food inflation is a bad mix.
- A Presidential election that has now become a clearly defined “policy battle” with one side of the fence clearly not supportive of the present Fed approach if elected therefore becomes one of the only catalysts for an early move but would likely be perceived as way too political.
They are some of the reasons for moving. The reason for not moving is that it could be a mistake, one step too far. What is the consequence of being wrong to move - the likelihood of inflation in a debt laden economy.
While as in the 1970’s this would be painful and likely create a “stagflationary” economic dynamic it is an acceptable outcome in a “debt laden economy” (the lesser of two evils argument)
From a Fed perspective this decision process looks to becoming less linear and more in favour of renewed balance sheet expansion.
Do we believe this is the right way to go? Probably not.
Do we think it will ultimately be inflationary? Yes.
However what we think does not matter.
What we think the Fed thinks is what matters and we are starting to think that a move is becoming more , not less likely, just as the market and possibly even the Fed seems to be thinking otherwise. A move in September now certainly looks less likely but ironically the lack of a move may see the Fed once again “behind their curve” and scrambling to catch up again in late 2012/early 2013.
Succinctly summarized thus:
1. What we have to pay for is rising in price (oil and food)
2. What we choose to pay for is falling in price reflecting stresses on the consumer and businesses alike.
This is not a positive dynamic in a very uncertain environment.
The most concerning chart is Oil which we fear will break higher and ultimately create a negative feedback loop that could at some stage become a negative backdrop for equities.
Europe will suffer most given their economic fragility and currency weakness.