There’s hope for a last-minute deal in the US
The Federal Reserve’s announcement of a new round of quantitative easing is welcome, but the ‘fiscal cliff’ remains a concern
The headline news in the US earlier this month was the US Federal Reserve’s announcement of a new round of quantitative easing, whereby the central bank plans to buy $40bn (£25bn) of mortgage-backed securities on a monthly basis without a predetermined end date.
The Fed also pushed back the timeframe on how long it will maintain its current policy of keeping interest rates near zero. It indicated that current interest rates should be in effect through to the middle of 2015.
While the fact that the Fed announced new easing plans was not unexpected, the aggressiveness of the plan and its open-ended commitment came as a positive surprise to observers. Equity markets jumped on the news, with the Dow Jones Industrial Average climbing 2.2 per cent to 13,593, the S&P 500 index rising 1.9 per cent to 1,465 and the Nasdaq Composite advancing 1.5 per cent to 3,183 for the week.
In contrast to market action following previous Fed easing announcements, there was also a significant sell-off in bonds and an increase in inflationary expectations.
The pending US ‘fiscal cliff’ has been much in the news lately and its ultimate resolution is far from certain. We still hold out hope that there is a better-than-average chance Congress can come to some sort of agreement during a last-minute lame duck session after the November elections to soften or delay some of the scheduled provisions.
For this to happen, the Democrats would have to accept some sort of extension of the scheduled tax cuts and the Republicans would need to agree to delay some spending cuts. Should the parties not be able to come together on a deal, the political environment could become more difficult in 2013.
In addition to politics, investors are also retaining their focus on US economic fundamentals. Data continues to be mixed, with housing and retail sales trending down a bit a couple of weeks ago and industrial production looking a bit better.
We are still maintaining our view that US growth should trend near the 2 per cent level for the time being.
Outside the US, we would note that concerns over the European debt crisis continue to percolate. The European Central Bank has committed to using its balance sheet to support the euro, but downside risks for the region remain.
Growth is slow, the banking system is troubled and policymakers still need to chart a path forward so different eurozone nations can integrate their fiscal policies.
Additionally, turmoil in the Middle East and elsewhere has been heating up. In addition to the violent protests occurring at US embassies, concerns are growing over Iran’s uranium enrichment programmes. The possibility of a unilateral Israeli strike on Iran is a worrisome one and would have unforeseen effects on the global economy and financial markets.