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Wednesday December 16, 2009 - 20:38:01 GMT
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David Gilmore's Alert. Views on FOMC Statement, Narratives

From FXA On-line:  email reply for access ( – also on FXAFX1 on Reuters.


   [19.35/14.35] Upgrade in labor market assessment and ongoing recovery are pretext for near-term tightening?  Depends on what the meaning of tightening is...removing exceptional liquidity measures may not be definition of policy tightening in most quarters.  Reducing the size of its balance sheet?  Fed simply repeated it would end the expansion of the balance sheet quite likely as planned at the end of Mar...but this does not mean selling assets or reducing the balance sheet.  And lastly the statement renewed its pledge to keep rates exceptionally low for an extended period of time.  Normalization from where I sit is more tortoise than hare and this is driven by Bernanke's view that there are far worse consequences from deflation if the Fed exits too soon than inflation if it hangs around too long with full punch bowl.


   [19.25/14.25] So Fed did little to signal retreat from unconventional that was not already known - letting liquidity measures expire as planned, asset purchases to taper to conclusion in end-Q1 (far from unwinding).  And clearly conventional monetary policy is on hold indefinitely...think 2011 is earliest for Fed tightening barring unforeseen V-shaped recovery. 


Would point out that the ECB, which has largely stuck to exceptional liquidity provisions and done little to grow its balance sheet (QE or monetizing), hinted at its last meeting that it was starting to pull back from liquidity measures and stress this did not imply a change in monetary policy (read conventional).  The EUR was little impacted by the ECB liquidity news.  From where I sit, the next real Fed news is what happens to mortgage spreads when the Fed stops new asset purchases (frankly I see little risk of the Fed selling its mountain of GSE MBS and debt as far as the eye can see…indeed it is not clear there will be a mortgage securitization market without the Fed buying much of what is on offer from the GSEs. 


In terms of the USD it seems to want to go higher on risk-elevating events like sovereign credit downgrades and on risk-suppressing events like strong payrolls and retail sales.  So the fact that the USD is firmer on the heels of the FOMC statement is not totally surprising (even got knee jerk dollar weakness initially). 


Again my thesis for the next powerful leg up in the USD rests on a powerful move down in equities…the one asset class in the risk-on trade that has yet to correct.  And since I see the risk narrative prevailing ahead the dollar can only go up so far without stocks going down before it tops out and we see mean reversion to longer-term dollar downtrend.


I also look forward to how the Fed picks up the pieces in rates land when its footprint in mortgage and bond market shrinks and it is back to markets finding equilibria.  Will housing hold up if mortgage rates spike 100bps in April?  What happens to US debt service if US Treasury yields soar on expectations of stronger activity, higher official rates and inflation expectations?  Or what does the Fed do if the economy faces a douuble dip likelihood when its liquidity support measures in place since last year expire? 


Frankly to get back to a normal narrative to explain past and likely future changes in asset prices and FX, I think the economy here in the US and elsewhere have to normalize…stand on their own feet without the explicit support of governments and central banks.  That could prove to be a very long wait.  Short of a normalizing in private-public support for the economy, the risk aversion (correlation, carry trade) narrative should prevail.


David Gilmore



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