By Ambrose Evans-Pritchard Economics Last updated:
September 20th, 2010
Here is a back-of-an-envelope guess by David Greenlaw at Morgan Stanley on what the Fed can expect from a second blitz of bond purchases, or `Shock & Awe’ as he calls it.
If Ben Bernanke does a further $2 trillion (on top of the $1.7 trillion already in the bag) the yield on 10-year US Treasuries will drop 50 basis points to around 2.2pc.
GDP growth will be 0.3pc higher than otherwise in 2011 and 0.4pc higher in 2012.
The unemployment rate will be 0.3pc lower in 2011 and 0.5pc lower in 2012 — (in other words drop from 9.6pc to 9.1pc, ceteris paribus).
That looks like trivial returns for a collosal adventure into the unknown, with risks of dollar flight and mounting Chinese suspicions that the US intends to default on its external debts by debasement.
I had dinner recently with a former Goldman Sachs hedge fund guru, and while I can’t remember the exact details through a fog of Mersault Premier Cru, I am pretty sure he said it would take $30 trillion to do the job – given the scale of wealth destruction from the US property crash and ferocity of debt deleveraging still to come.
We will find out tomorrow whether Fed hawks from such districts as Dallas, Richmond, Kansas, and Philadelphia are really willing to sign off so soon on the next helicopter drop. It seems very strange that they should do so when the official line is that there will be no economic double-dip, and that this Summer’s slowdown is just a mid-cycle correction.
Bernanke said at Jackson Hole that the Fed would hit the button “if the outlook were to deteriorate significantly”. Has that standard been met? I happen to think that the underlying conditions have been buckling for months – if you look at forward-looking indicators rather than backward-looking indicators (the internals of the ISM for example) – and that the economy is slowing to stall speed as the inventory boost wears off, housing support is snatched away, and fiscal tightening bites.
BUT THAT IS NOT THE FED’S STATED VIEW. If it were to sign off on fresh QE as cavalierly as some analysts seem to suppose, it would invite ridicule. Such action would suggest there really is a Bernanke Put, a safety net for asset prices, investors, and the rich.
Whatever Bernanke may think in private – and I am sure that he would dearly like to get ahead of the curve with fresh `credit easing’ [his term] to limit the tail-risk of deflation – he cannot even command the unity of the Fed Board in Washington. Kevin Warsh seems to share much of the scepticism of the hawks.
On another note: here is a chart from the Morgan Stanley Strategy Forum on the main tradable currencies:
It speaks for itself. Sterling is the most undervalued. The Aussie and Kiwi are the most stretched. No wonder Goldman Sachs is advising clients to go long sterling/short kiwi as one of their top trades.
There again, mean reversion always looks deliciously simple but never quite works the way you think.