What Wall Street economists and strategists had to say about key developments on Jan. 19
By BW Staff
Bloomberg BusinessWeek compiles comments from Wall Street economists and strategists on the key economic and market topics of Jan. 19. Michael S. Hanson, Bank of America Merrill Lynch [I]nflation worrywarts point to…the expansionary monetary and fiscal policies currently in place. Even if we avoid an acceleration of inflation in the next year or two, the argument goes, it will be virtually impossible to avoid higher inflation down the road as a consequence of these policies. On the monetary side, the unprecedented amount of excess reserves sloshing around the banking sector is seen as a potential inflationary time bomb. However, bank lending is still down sharply; consumer credit contracted a record $17.5 billion in November. Lending won't suddenly explode overnight, thus allowing the Fed ample time to implement the various reserve-draining tools it has been testing. Should a significant inflation threat actually materialize, the Fed could sell some assets from its balance sheet as well. Finally, with the ability to pay interest on reserves, the Fed should be able to short-circuit the mythical money multiplier. On the fiscal side, large budget deficits and soaring debt issuance cannot cause inflation unless monetized by the central bank. Various Fed officials have swore they have no intention of doing that; in a speech earlier this month, Vice-Chair Don Kohn promised "the fiscal situation will not impede timely tightening." The Fed's decision to end the Treasury purchase program at $300 billion lends some credence to this asseveration. The key will be if Congress upholds its end of the bargain when it comes to Fed independence. The delay in Bernanke's reappointment vote is symptomatic of a populist backlash against the Fed that has been codified into an "audit" provision contained in the House financial reform bill. While we have previously written on this point, we could scarcely be as eloquent as Dallas Fed president Richard Fisher regarding the dangers stirred up by this precedent: "Making the discussions held by me and my colleagues at the FOMC subject to congressional second-guessing…can only lead us straight to the fate that was suffered by once great economies like pre-Weimar Germany and pre-Peron Argentina." Jan Hatzius, Goldman Sachs We have boosted our estimate for fourth-quarter [U.S.] growth to 5.8%, from 4.0% (annual rate). However, about two-thirds of this growth represents a sudden stabilization in inventories after sharp declines earlier in the year. Final sales appear to have risen at only about a 2% annual rate with little sign of improvement, judging from the latest data on hiring, retail sales, and housing demand. Last year we estimated that temporary housing policies—Fed asset purchases, federal loan modification programs, the homebuyer tax credit, and [support of government-sponsored enterprises Fannie Mae and Freddie Mac]—boosted home prices by 5%, accounting for most of the gains during 2009. Since then, the strength in home prices has begun to fade, and the transition away from policy support will also weigh on the market. We expect the Fed's asset purchases to end on schedule. If mortgage rates rise in response, the GSEs' ability to purchase [mortgage-backed securities] will provide only modest help. The Administration has clear motivation to pursue more aggressive loan-modification strategies and additional efforts are likely. However, it is not clear that broadly applied principal writedowns will be among them. The homebuyer credit appears to have been an even more powerful incentive than we thought. Revised data imply roughly 400,000 extra first-time purchases in 2009. The credit will expire after April and another extension looks less likely. The GSE reform process will start two weeks from now; explicit guarantees combined with private capital and strict regulation seem most likely to be proposed in the Administration's forthcoming budget. However, enactment this year looks difficult, if not impossible. Now that would be something worth worrying about. Russell Jones, RBC Capital Markets A general election must be held in the U.K. by June 3. While the opposition Conservative Party enjoys a comfortable lead in the opinion polls, there is no guarantee it will secure an overall majority. There is a significant chance of a minority or a coalition government, which could necessitate a second election in relatively short order. Britain has little modern-day experience of such outcomes. The last time the nation was faced with these circumstances was in the unloved and unmissed mid-to-late 1970s. There are some ominous similarities between the economic situation today and that of 35 years ago, not least in the condition of the nation's public finances, but the similarities should not be exaggerated. The 1970s were a very different era—a period of almost unrelenting trauma, during which new and unfamiliar shocks, rampant inflation, and widespread industrial unrest took the complexities of economic management to an unparalleled level and frequently found policymakers wanting. Notwithstanding the errors of recent years (and there have been many), since that time knowledge of how the economy works, the institutional environment, and the policy architecture have all improved considerably. However, this is not to belittle the extent of the U.K.'s fiscal crisis or to deny the huge challenges ahead, especially given the burgeoning costs associated with an aging population. Britain is not yet headed back to the 1970s, in our view, but such economic and political recidivism cannot be ruled out. Policy makers and money managers would do well to consult their history books and be alert to the errors and failings of 35 years ago. Kim Rupert, Action Economics The fiscal problems of Greece haven't been lost in translation to the financial markets. Investors have had no problem understanding the consequences of the nation's financial mess, which is in part viewed as a microcosm for debt problems that could manifest globally. Indeed, demand for the safety of Treasuries and [German government debt] picked up last week, while stocks stumbled out of the 2010 gate, in part amid concerns that Greece's fiscal woes are just the tip of another financial iceberg. While it might be a bit far-fetched to extrapolate the deficit problems of Greece (and other euro zone nations Spain, Portugal, Ireland) out to the collapse of the euro zone and the potential ruin of G7 economies, as well as to the sustainability of global economic recovery itself, investors aren't taking any chances. The euro fell over 0.8% vs. the dollar on Jan. 15, to $1.4378, which compares to $1.5100 in late November, before Greece really became front page news. The [German] Bund had its best week since November, and the yield dropped to 3.26%, its lowest since Dec. 21. The Treasury 10-year yield dropped 16 basis points last week to 3.67%, also the lowest since Dec. 21. Investors will remain spooked by Greece in particular this week, and by rising worries over the health of the recovery following disappointing data out of the U.S. and indications China is starting to normalize policy. But trading is likely to turn more…cautious after the big price moves last week, especially as there aren't any game-changing data or events on the global calendar.