Bernanke did warn policymakers about the nefarious effects of “the so-called fiscal cliff,” noting that a “sudden and severe
contraction in fiscal policy” posed a major risk to what has been a feeble recovery.
The Chairman’s speech came with no surprises. The speech avoided talking about further quantitative easing, keeping to the
usual language of FOMC statements, leaving the door open but neither announcing nor rejecting QE.
According to Bernanke, a weak housing sector caused by an oversupply of foreclosed properties has dried down the green
shoots of recovery.
Subsequently, concerns in Europe over the sovereign debt crisis could provide additional turbulence going forward. This has
fastened the process of risk aversion across the globe.
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US is also heavily indebted and the removal of QE has further cheapened sovereign bonds. This is an argument against
reversing QE.
With economy not showing signs of recovery and interest rates still at all time lows, the problem of an exit looks even more
pressing.
US needed inflation expectations to ward off the risk of deflation. However, considering the current exogenous shocks such as
commodity price volatility and the risk of inflation imported from the emerging markets, inflation can still be a party spoiler.
Operation Twist is concluding this month, and clamour for fresh round of easing has never been louder than before.
All eyes will be glued to the FOMC meeting this week where commentary will hold vital cues on the next round of easing
Weak economic data has been the drag on recovery.
3-month moving average of private payrolls is drifting lower suggesting weakness persisting in economy. Similarly, ISM
manufacturing index after exhibiting some resilience is also loosing the momentum.
Unemployment rate which has shown downtick has again started to move up, adding to the woes.
QE: A Catch 22 situation for the Fed
After the announcements of quantitative easing
(QE) exercises, the currencies have come under
pressure driven by risk-on trades.
With the QE efforts not meeting the expectations,
the Federal Reserve launched “Operation twist” in
September 2011 with an objective to lower the
long term interest rates (selling short term bonds
and utilizing the cash proceeds to fund the
purchase of long dated ones) to aid the ailing
state of mortgage and lending in the economy.
Considering the European crisis and weakening
economic data, flight to safety has become even
more pertinent. This has pushed down yields
across maturities, which certainly does not serve
the Fed’s long-term purpose.
Moreover an easing exercise can reinvigorate the
risks of commodity driven inflation in the
economy.
A stimulant to commodity prices
QE3 may not come before yet another bout of market pessimism.
Needless to mention, quantitative easing (QE) has been a stimulant for risk assets.
Notwithstanding the argument of safe heaven remains, liquidity has played its due role in supporting the yellow metal.
As history suggests, gold may move back to its all time highs on the back of expectation of QE3.
Closing comments
With operation Twist concluding this month, the slowing growth has given the Fed enough reasons to unleash a fresh round of
easing.
In a poll of 21 primary dealers who trade with the central bank, surveyed by the Bloomberg, 12 of them are expecting the Fed
to announce new steps to boost the economy.
A pertinent observation by the remainder highlighted the fact that as yields are at near all-time lows, effectiveness of more
measures by policy makers will be limited.
Edelweiss Vital Insights
If excerpts are to be believed, the intensity of easing this time around is likely to be much stronger than earlier ones.
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