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The more difficult decisions will come as QE2 nears completion and the Fed has not made much progress on its mandates The real debates will occur as we move toward completion of the programme. No member of the FOMC has indicated that he or she expects significant progress on the Fed’s dual mandates for maximum employment and stable prices, but the tone of the economy will set the tone of the policy debate. Should the economy continue to perform reasonably well, even if final demand growth moderates from what should be a very strong Q4, there will be strong opposition from the hawkish members to any further expansion in the balance sheet. At this point, it seems that further expansion of securities purchases would require significant deterioration in the economy. Such a scenario would also raise questions about the efficacy of Fed policy to date, however. There is thus certain to be opposition to QE3 in any case. The most likely path of policy would be completion of QE2, maintenance of the balance sheet for some time as progress toward the mandates will be slow in coming, then allowing maturing securities to gradually reduce the size of the Fed’s portfolio. Once i) the unemployment rates has fallen to 8.5% on job growth, rather than decline in labour force participation; and ii) wages have begun to stabilise, suggesting gradual improvement in purchasing power that will stabilize core inflation, the Fed will be ready to normalise rates to 1.0%. The Fed has tools in place, including the Term Deposit Facility and reverse repos, that it believes will help sterilise the trillions of dollars in excess reserves and give it greater control over short-term rates. Thus the FOMC believes it will be able to raise rates even as it maintains an elevated balance sheet. This is a shift from the last time we thought about the sequencing of Fed tightening. At the beginning of last year, we were thinking that the Fed would have to bring down excess reserves to a considerable degree before tightening could get underway, which could include asset sales. However, Chairman Bernanke stressed in a speech in late October 2010 that, with the liquidity absorption tools the Fed has developed: “I am confident that the FOMC will be able to tighten monetary conditions when warranted, even if the balance sheet remains considerably larger than normal at that time.” We continue to think that tightening is a good way off given the pervasive weakness in the US economy that remains even after a solid quarter of growth. While many global investors and policymakers believe the Fed should consider the global ramifications of its policies, the FOMC is likely to continue to focus on its domestic mandates. We are in a period of increasing dichotomies; global markets and policymakers have calibrated their policies based on Fed actions in prior cycles. However, the US is lagging global performance in the current recovery. This is leading to rising tensions as the Fed stays easy and emerging-market central banks are reluctant to tighten even as their economies verge on overheating. Julia Coronado 20 January 2011 Market Mover 12 www.GlobalMarkets.bnpparibas.com
Canada: Betting on Investment and Exports • The Bank of Canada has an optimistic outlook for its economy, based on a CAD at parity with the USD and high commodity prices. • We see the BoC’s outlook for the US as too bullish and the CAD appreciating further. • Risks for a hike later than our projected policy tightening in June lie with the CAD. 30 20 10 0 -10 -20 Chart 1: Imports vs Exports (3m % y/y) Imports Optimistic The Bank of Canada left the policy rate at 1.00% at its meeting on Tuesday. While the BoC’s statement was slightly more hawkish than expected based on an improved global growth outlook, we think risks are building that our projected rate hike in late Q2 gets pushed back. The BoC focused on stronger-thanexpected private demand growth in the US and Europe. However, it also noted that continuing strength in the CAD poses downside risks to the generally stronger outlook. The Monetary Policy Report indicated the BoC expects the CAD to weaken, averaging parity with the USD in 2011 and 2012. In contrast, we expect continued appreciation in the CAD in coming months, suggesting downside risks to the BoC’s export outlook. In addition, our own view of the US outlook is a more subdued than the BoC’s, also suggesting the possibility of delay should the US hit a softer patch. The BoC statement and Monetary Policy Report highlighted that stretched household balance sheets are expected to restrain the pace of consumption growth and residential investment, while business investment should continue growing solidly. Net exports are also expected to contribute positively to growth going forward. Exports and investments are key In Q3 2010, we saw a 5.0% q/q a.r. decline in exports, while investment posted weak, 0.9% growth. The BoC expects a recovery in both going forward, based on a stronger external outlook. In addition, recall that corporate tax rates were reduced from 18.0% to 16.5% for 2011. Since the third quarter, the CAD has appreciated 4.5%, and export data in November show a decline in the 3m y/y trend for exports. However, there has also been a decline in the 3m y/y import data (see Chart 1). The monthly trade balance improved in November, while the 12m -30 -40 Exports Jan 00 Jan 03 Jan 06 Jan 09 Source: Haver Analytics 90 80 70 60 50 40 30 20 10 0 -10 -20 Chart 2: Trade Balance (CAD bn) 12m accum Trade Balance Jan 00 Jan 03 Jan 06 Jan 09 Source: Haver Analytics Monthly Trade Balance Chart 3: Consumer vs Industrial Prices (% y/y) 10 8 6 4 2 0 -2 -4 -6 -8 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Source: Haver Analytics CPI Industrial Price Index accumulated trade balance continued to deteriorate (see Chart 2). Exports are smaller than imports in value so a net positive contribution to GDP growth would require a more significant improvement in exports. A rising CAD puts that scenario at risk, with 10 8 6 4 2 0 -2 -4 Bricklin Dwyer 20 January 2011 Market Mover 13 www.GlobalMarkets.bnpparibas.com
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Page 31 and 32: US/EUR Spreads: Further Tightening
Page 33 and 34: US: Could the Short End Have a Puls
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EURUSD Rally Eyes 1.3750-1.3950 •
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Currency Spot Trade Recommendations
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than an unrelenting rise in prices
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Economic Calendar: 21 - 28 January
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Key Data Preview 120 115 110 105 10
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Key Data Preview Chart 5: French Sa
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Key Data Preview 10 5 0 -5 -10 -15
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Key Data Preview 3 2 1 0 -1 Chart 1
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Economic Calendar: 31 Jan - 25 Feb
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Next Week's T-Bills Supply Date Cou
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Economic Forecasts GDP Year 2010 20
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Market Coverage Market Economics Pa
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