Experts Talk Fed Exit Strategy, Trade, Greek Bailout

by BW Staff

Bloomberg BusinessWeek compiles comments from Wall Street economists and strategists on the key economic and market topics of Feb. 10.

Michelle Meyer, Barclays Capital

Fed Chairman Bernanke provided more clarity about the Fed's exit strategy from the current accommodative policy stance. In fact, he outlined a possible sequence: 1) Test its tools for draining reserves, which include reverse repos and term deposits…. 2) "Scale up" draining operations to drain more "significant volumes of reserves to provide control over short-term interest rates." 3) Hike the interest paid on excess reserves rate. Bernanke said that if the Fed deems it appropriate to exit more rapidly, it could choose to hike the [rate] at the same time it engages in significant reserve draining. The sequence Bernanke outlined is consistent with our forecast that the Fed will begin large-scale reserve draining in midsummer, followed by interest rate hikes in September.

The last step the Fed will take will be to sell assets. Bernanke said he does not expect to sell any of the Fed's security holdings until "after policy tightening has gotten under way and the economy is clearly in a sustainable recovery." However, it will allow the MBS [mortgage-backed securities] and agency debt to run off as they mature or are prepaid. It is less clear if the Fed will roll over maturing Treasuries.

Bernanke also provided clarity on the policy target in the near term. Since it may be difficult to target the fed funds rate, given the conditions in short-term money markets, the Fed may use the interest-paid-on-excess-reserves rate in combination with targets for reserve quantities as the guide. However, once reserves have been sufficiently reduced, the Fed would return to targeting the fed funds rate. Bernanke [made] certain to state that the Fed has yet to make a decision on this matter. Bernanke also mentioned that as part of the "normalization" of the liquidity facilities, the Fed may consider a modest increase in the spread between the discount rate and [the] target fed funds rate.

While Bernanke provided more detail on the exit process, he did not provide much more insight into the timing. Indeed, he reiterated that the Fed expects conditions to warrant exceptionally low levels of the fed funds rate for an extended period.

David Wyss and Beth Ann Bovino, Standard & Poor's

The U.S. trade deficit widened to $40.2 billion in December, from $36.4 billion in November. The consensus [estimate of economists] was for a flat $36 billion trade gap. Exports rose $4.6 billion to $142.7 billion, but imports were up $8.4 billion to $182.9 billion. The trade gap is the worst of 2009 and brings the annual deficit to $380.7 billion, still far below the $695.9 billion of 2008.

The services surplus was flat at $11.9 billion, but the goods balance deteriorated to a $48.5 billion deficit, from $47.0 billion in November. Most of the import rise was accounted for by petroleum, which rose $3.6 billion to $28.1 billion. The non-oil deficit narrowed to $26.9 billion, from $27.2 billion. The increase in petroleum imports was split about equally between higher prices and higher volumes, with volumes up 14% on colder weather and a rebound from low import volumes the previous two months. The export rise was split between capital goods (up $1.8 billion) and industrial supplies (up $1.6 billion). The capital goods rise was mostly civilian aircraft (up $1.1 billion). Other than petroleum, there were sharp increases in imports of capital goods and autos (up $1.6 billion each).

Regionally, the deficit with China narrowed to $20.0 billion, from $23.1 billion. For 2009 as a whole, the deficit with China was $268 billion, or 33% of the total.

The report is worse than expected, although concentrated in oil. It gives further reason to expect a downward revision to fourth-quarter [gross domestic product].

Edward McKelvey, Goldman Sachs

Given our weaker-than-"consensus" view that growth will slow materially during the first half of 2010 from the 4% annualized pace of the second half of 2009, we figure it's time to offer another road map of indicators consistent with that outlook. For the consumer, we expect moderation in the growth rate of non-auto sales, but a modest increase in auto sales to just over [an] 11-million-unit annual rate, and only small gains in consumer confidence. In the housing sector, sales and starts of new, single-family homes should increase from depressed levels posted for December but otherwise remain subdued, while construction outlays for nonresidential [buildings] continue to drop. Manufacturing activity should keep growing, but at progressively slower rates relative to the brisk increases seen in the second half of 2009. The ISM index, which ran against this expectation by surging in January, should eventually settle back to 55 or a bit lower. Within the durable goods report, capital goods orders should hold up fairly well, given our positive outlook for equipment spending and exports.

Although we continue to have a more cautious view on the labor market than most other forecasters, we do expect nonfarm payrolls to start rising—perhaps as soon as this month—and reach an average gain of 100,000 during the spring. Coupled with the Census hiring, this will likely keep the unemployment rate around 9.75% over the next six months, after which we expect it to drift up to a new cyclical high of 10.50% in early 2011. Our labor market view also implies a further drop in initial claims, to below 400,000.

On the inflation front, we expect sticky headline increases in consumer prices over the next month or two but otherwise see smaller increases in both headline and core price indexes, to less than 0.1% in the case of core.

Vassili Serebriakov, Wells Fargo Bank

There have been several twists and turns in the Greek fiscal drama over the past 24 hours. Yesterday's press reports that German officials were discussing a bailout plan lifted the euro and weighed on the dollar more broadly. Today's newswire headlines have been less optimistic, however, with some officials quoted as saying the ECB and the EU disagree with the Greek government on the size of the necessary fiscal adjustment.

We suspect the markets are not rushing to wholeheartedly embrace the notion that the worst is behind us at this point. Moreover, even if a bailout plan brings relief to Greece, it may be seen as effectively encouraging fiscal irresponsibility in the euro zone. While the latest news is helping stabilize the dollar, the Japanese yen is recovering after somewhat disappointing trade numbers from China and the U.S.

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