Risky asset markets are booming, US growth is set to resume with a bang in 3Q09 and the ISM has bounced solidly off its lows. Yet central bank officials have remained active in warding off attempts by markets to price in early hikes in policy rates. Experience from the previous three recessions in the US suggests that the Fed is likely to look through improvements in GDP and the ISM. Instead, its rate hikes have coincided strikingly with an upturn in inflation expectations. In our view, the biggest risk to medium-term growth is a policy mistake. Stronger-than-expected growth over the next few quarters may lead to a rise in inflation expectations, which may in turn prompt a premature start to the tightening cycle, as it seems to have done in the past.
[I]Manoj Pradhan, Global Economics Team, Morgan Stanley [/I]
[B]Weekly Bank Research Center 09-2809[/B]
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[I] Manoj Pradhan, Global Economics Team, Morgan Stanley [/I]
Risky asset markets are booming, US growth is set to resume with a bang in 3Q09 and the ISM has bounced solidly off its lows. Yet central bank officials have remained active in warding off attempts by markets to price in early hikes in policy rates. Experience from the previous three recessions in the US suggests that the Fed is likely to look through improvements in GDP and the ISM. Instead, its rate hikes have coincided strikingly with an upturn in inflation expectations. In our view, the biggest risk to medium-term growth is a policy mistake. Stronger-than-expected growth over the next few quarters may lead to a rise in inflation expectations, which may in turn prompt a premature start to the tightening cycle, as it seems to have done in the past.
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[B] UK: Mervyn Stealing The Headlines [/B]
[/B] [/B][/B] [I] Allan von Mehren, Chief Economist, Danske Bank[/I]<em>
In recent months the UK economy has shown many signs of recovering from the historically deep recession it entered in 2008. Industrial production is starting to rise again, PMI data and leading indicators point to further improvement ahead, and housing has shown clear signs of improvement in both sales and house prices. However, there is still widespread uncertainty about the strength of the recovery and the sustainability. Bank of England members – not least the governor Mervyn King – have expressed a high degree of caution in interpreting the recent more positive signals. Even though the overall message from the minutes of the latest BoE meeting was one of more comfort, Mr King and two other members argued that an increase in the asset purchase programme could still be justified. In the end, the committee voted 9-0 to continue the programme as planned.
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[B] FOMC: Setting Up for the Exit [/B]
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[I] John E. Silvia, Ph.D. Chief Economist, Wachovia[/I]
The press release for this week’s Federal Open Market Committee (FOMC) meeting suggested that the FOMC “continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time,” and yet also will complete its purchases of Treasuries by the end of October. This would suggest that the yield curve will be biased towards steepening as reduced Fed buying and continued Treasury issuance will raise interest rates—particularly given recent weakness in the dollar. Moreover, the FOMC sees “that economic activity has picked up” and this should reduce the flight-to-safety trade.
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[B][B][B][B][B] United States – Walking a Tight Rope [/B][/B][/B][/B][/B][B][B][B][B][/B][/B][/B][/B]
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[I] Diana Petramala, Chief Economist, TD Bank Financial Group [/I]
The U.S. leading indicators were up 0.6% in August, the fifth consecutive monthly gain, serving as a good indication that economic activity continued to over the third quarter. While we expect real GDP growth to jump 4.0% annualized in that quarter, the vast amount of fiscal stimulus pumped into the economy during the economic downturn was likely a large contributor. Excluding the stimulus the U.S. domestic economy still remains too fragile to carry this momentum forward on its own.
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[B][B][B][B][B] UK Economy Faces Long Slog to Regain GDP Peak [/B][/B][/B][/B][/B][B][B][B][B][/B][/B][/B][/B]
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[I] Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]
In recent comments to the Treasury Select Committee on economic affairs, Mervyn King, the Governor of the Bank of England, said that “UK economic recovery would be slow and protracted” and added that “It is very important not to lose sight of the fact that growth rates do not tell the whole story. It is the levels that matter”. With increasing signs that the UK economy will return to growth in the current quarter after a deep downturn, the intention appeared to be to damp expectations of a swift return to normality, including the prospect that(even with some rise in growth) interest rates would be raised anytime soon. Indeed, the Governor suggested that there could be further quantitative easing (QE) in November.
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[B][B][B][B][B] Other Pre-screened Independent Contributors[/B][/B][/B][/B][/B]
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[I] J-Chart [/I]
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[I][B]Compiled By: David Song, Currency Analyst and Michael Wright[/B][/I]