For an economy still vulnerable to adverse shocks and where even the central bank is taking pot-shots at the inaction of government, the policy options look increasingly limited. The dollar has grown weary of sizeable quantitative response which most investors blindly accept as swelling the supply of money. Even the lingering whiff of inflation has some of its patrons opposing more of the same. Gaining strength now is the proposal that the Fed "twists" its balance sheet by both buying and selling securities at opposing maturities specifically to level the yield curve to encourage refinancing and spur consumption. My 10% auto loan and 28% credit card interest payments – a tax by any other name – might soon become relics of an "old-style" economy.
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U.S. Dollar – The dollar turned decidedly lower as equity index futures jumped higher. Investors are rapidly discounting the onset of further quantitative easing in light of the August FOMC minutes. It turns out that the big news was not that three committee members were opposed to putting a sell-by date on the central bank’s short-term rate of interest, rather that some of its members favored deeper measures to aid the economy. The prospect of further quantitative easing is currently weighing on the dollar yet bears might need to exercise caution ahead if indeed the Fed performs what some have coined “operation twist.”
Some FOMC members are concerned that clear signs of inflationary pressure resulting from the first two rounds of quantitative easing will only worsen should the Fed pour oil on flaming waters through further policy measures. For those members the risk is that resulting higher prices remain etched into the economy without having achieved the significant benefit of faster growth or lower unemployment.
The proposal on the table raised by the likes of Bernanke who aim to shatter the objection of the hawks, is to change the composition of the Fed’s balance sheet. By selling its shorter-dated maturities and buying longer-dated bonds, the Fed could further eradicate the gradient of the yield curve and encourage a wave of borrowing starting with refinancing from autos to credit cards. By maintaining the size of its balance sheet but by changing its maturity profile the Fed could achieve not only a valid increase in disposable income and raise the chance of spurring meaningful consumption, but it might also create consensus within the ranks in Washington.
Euro – So long as the dollar has the prospect of further quantitative easing at its door, the single European currency can breathe easy. That’s not to say that the euro is a risk-free bet given the long-drawn out failure of the region’s authorities to contain its growing sovereign debt crisis. Data released on Wednesday failed to alleviate the fact that the globe is slowing and that growth challenges are highly likely to remain in place. The region’s 2.5% pace of consumer price increases remained intact during July, repeating its prior performance. The euro doesn’t jump on such news these days as lingering hopes for a further monetary tightening have been dashed by the recent spate of crises. On Monday Jean-Claude Trichet remarked that the ECB was reviewing risks to inflation in light of slower growth facing the region. The euro remained unchanged at $1.4440 after Luxembourg statistics revealed the zone’s overall unemployment rate remained static at 10%.